In the Red – The Business Bankruptcy Blog

In the Red – The Business Bankruptcy Blog

The Business Bankrupty Blog

Cooley GO: A Great New Resource For Entrepreneurs And Their Companies

Posted in Business Bankruptcy Issues

Cooley Go

Cooley GO

Earlier this month, Cooley LLP launched Cooley GO, a terrific new resource center for entrepreneurs with businesses at all stages of the growth cycle. Cooley GO is a mobile-friendly microsite that provides a wide range of free legal and business content covering formation, financing, building a team, working with directors and advisors, intellectual property, M&A, IPOs and more.

I have the pleasure of being a contributor to Cooley GO. A new post I wrote called “A Key Customer Filed for Bankruptcy: Should You Keep Doing Business With Them?” is now on the Cooley GO site. To read the article just follow the link in the prior sentence.

Be sure to explore the full Cooley GO site. Among other tools, Cooley GO provides entrepreneurs with the ability to:

I hope you find Cooley GO to be a helpful resource for your business.

Why Creditors Can’t Afford To Ignore Objections To Bankruptcy Claims

Posted in Business Bankruptcy Issues

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It’s been several years since I last posted about objections to bankruptcy claims, and the topic is so important to creditors that it’s time to revisit it.

File And Forget? When a customer or other party with which you do business files bankruptcy, it’s important to file a proof of claim on time by the deadline (also known as a “bar date”) set in the case. Once you do, however, months or even years can go by before you hear anything more about your claim from the debtor, bankruptcy trustee, or other party responsible for reviewing claims and ultimately distributing money to creditors. In fact, the only thing you may hear about your claim for quite some time is an offer to purchase it made by one or more claims buyers.

No News Is Not Necessarily Good News About Your Claim. Unfortunately, the passage of time may lull you into thinking that no objection will ever be filed to your claim. However, the urgency of reorganizing a debtor’s business or liquidating its assets means that the claim objection process is typically left until near the end of the bankruptcy case, often after a plan of reorganization has been confirmed in a Chapter 11 case. Likewise, a Chapter 7 trustee may put off filing claim objections until it’s clear there will be money to distribute to unsecured creditors. As a result, an objection to your claim may be brought long after you filed it, often years later.

Is That An Objection To My Claim? When an objection is filed, it may not always be obvious at first that it applies to your claim. In smaller cases the title of a claim objection may list your name as the target of the objection, but don’t count on that in larger cases. In cases with hundreds or thousands of claims, the debtor or other estate representative will almost certainly combine an objection to your claim with others. Instead of a pleading specifically mentioning your name in its title or text, the objection will likely have the word “omnibus” in it and may have a name such asNotice of Debtors’ One Hundred Fifteenth Omnibus Objection To Claims (No Liability)” or some similarly titled document.

  • Be careful: the format of these objections can be a trap for the unwary. Buried within the objection’s many pages of text and attached exhibits may be just a few lines, often only in a list or chart, identifying your claim as one of dozens to which an objection has been filed.
  • Given the passage of time, the debtor may have sold — and changed — its name, so the name of the debtor listed on the objection may not even be familiar to you (although the old name should appear near the new one).
  • When filed, the objection may assert (1) your claim should be zero, (2) the amount doesn’t square with the debtor’s books and records and should be less, or (3) your claim should be reclassified as some lower priority claim (for example, from a priority claim to a general unsecured claim).
  • Whatever the objection’s name or format, the point is the same: ignore it at your peril. If you don’t file a formal response with the bankruptcy court by the deadline set in the objection (and there’s always a deadline) your claim could be disallowed in its entirety. If that happens, you will recover absolutely nothing from the bankruptcy estate.

Stay Vigilant To Protect Your Rights. Protecting your rights in a bankruptcy case requires diligence and timely action – often no easy task. In mega bankruptcy cases, literally thousands of pleadings can be filed during the course of a case. Many will be served, whether in paper or electronic form, and yet only a few may be directly relevant to you or your claim. For this reason, it’s critical that you or your attorney keep track of the pleadings served in a bankruptcy case. The bottom line is, if you see anything that looks like a claim objection, review all of the pages carefully, including the exhibits. If an objection to your claim is filed, you have to respond on time and defend your claim. Otherwise, despite your efforts earlier in the case to file a timely proof of claim, you may well find yourself with a disallowed, and worthless, claim.

Image Courtesy of Flickr by Sam Howzit

A New Way Of Looking At Termination On Bankruptcy Contract Clauses

Posted in Business Bankruptcy Issues, The Financially Troubled Company

Contract photo

Image Courtesy of NobMouse

Ken Adams, Professor Adrian Walters, and I recently collaborated on an article about the ubiquitous “termination on bankruptcy” or ipso facto clauses in contracts. The article was just published by the American Bar Association’s Business Law Section in its online publication, Business Law Today. It’s titled “Termination-On-Bankruptcy Provisions: Some Proposed Language” and is available by following the link. You can also download a PDF of the article.

The article offers proposed language for agreements governed by U.S. law and also by foreign law. I have posted on termination on bankruptcy provisions in the past, discussing how U.S. bankruptcy law usually — but not always — renders those clauses unenforceable. This new article recognizes those limitations but suggests proposed model language to address settings in which the provision is enforceable, together with an analysis of the specific language proposed.

I hope you find the article of interest.

Rejecting Jewel v. Boxer, The District Court’s Heller Decision Is A Potential Knock-Out Punch Against Unfinished Business Claims By Insolvent Law Firms

Posted in Business Bankruptcy Issues, Recent Developments, Uncategorized

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U.S. District Court in San Francisco

Image Courtesy of Ken Lund

The Order Re Summary Judgment issued on June 11, 2014 by Judge Charles R. Breyer of the U.S. District Court for the Northern District of California in the Heller Ehrman LLP bankruptcy case may prove to be a knock-out punch against “unfinished business” claims by insolvent or bankrupt law firms and their trustees. Judge Breyer not only granted summary judgment to four law firms that hired former Heller partners and engaged former Heller clients, but he also distinguished and rejected the 1984 California Court of Appeal decision in Jewel v. Boxer, 156 Cal.App.3d 171 (1984), the case that for years has been the foundation for unfinished business claims involving California law firms.

(For bankruptcy buffs, Judge Breyer’s decision may also have been one of the first to cite the Supreme Court’s Executive Benefits Insurance Agency v. Arkinson decision on de novo review of bankruptcy court decisions.)

The Heller Law Firm Bankruptcy. The Heller litigation arose out of a fairly common scenario when a law firm becomes insolvent or files bankruptcy. After Heller’s bank declared a default, Heller was unable to continue in business and voted to dissolve. Heller notified its clients that it would no longer be able to provide legal services and later filed Chapter 11 bankruptcy. The dissolution plan Heller adopted contained a “Jewel Waiver” purporting to waive any rights under the Jewel v. Boxer case to seek payment for legal fees generated on non-contingency matters after the departure of any Heller attorney.

The Trustee Sues Other Law Firms. After the bankruptcy, the trustee sued various law firms, which had hired Heller partners (called shareholders under Heller’s structure), alleging that under Jewel v. Boxer the Heller estate had property rights in the unfinished hourly matters pending at the time the former Heller lawyers joined other law firms. The trustee alleged that the Jewel Waiver was a fraudulent transfer of Heller’s property rights in those unfinished hourly matters.

The Jewel v. Boxer Case. To give some context, the Jewel case involved a four-partner law firm that voluntarily chose to dissolve into two, two-partner firms. Each new firm continued representing their respective clients under fee agreements entered into between each client and the old law firm. On those facts, the California Court of Appeal in Jewel ruled that by taking that business with them after dissolution, the former partners violated their fiduciary duty not to take any action with respect to unfinished business of the partnership for personal gain. This principle has prompted bankrupt law firms and their trustees to bring so-called “unfinished business” litigation against law firms that hire former partners and take on continuing matters from a failed law firm.

Jewel Distinguished (If Not Extinguished). In Heller, Judge Breyer framed the issue presented this way:

A law firm—and its attorneys—do not own the matters on which they perform their legal services. Their clients do. A client, for whatever reason, may summarily discharge counsel and hire someone else. At that point, the client owes fees only for services performed to the date of discharge, and his former lawyer must, even if fees are in dispute, cease working on the matter and immediately cooperate in the transfer of files to new counsel.

It is in this context that the Court is asked to address a question of first impression: namely, whether a law firm—which has been dissolved by virtue of creditors terminating their financial support, thus rendering it impossible to continue to provide legal services in ongoing matters—is entitled to assert a property interest in hourly fee matters pending at the time of its dissolution.

In the heart of the decision, Judge Breyer distinguished Jewel from the facts in Heller, highlighting “five key, related reasons.” He went even further and, aiming directly at the Jewel decision, stated that the Court “is also of the opinion that the California Supreme Court would likely hold that hourly fee matters are not partnership property and therefore are not ‘unfinished business’ subject to any duty to account.”

I quote from the decision below, but here’s a quick thumbnail of these five key reasons the Court distinguished Jewel:

  1. Cause of dissolution: The dissolution in Jewel was voluntary; in Heller it was forced.
  2. New fee agreements: In Jewel the old firm’s fee agreements were used; in Heller clients signed new agreements with the new firms.
  3. Different firms: In Jewel all partners were from the old firm; in Heller the partners joined pre-existing firms that never owed duties to Heller.
  4. No contingency matters: Jewel did not distinguish between hourly or contingency matters; Heller involved no contingency matters.
  5. Superseding law: Jewel was decided under old Uniform Partnership Act; Heller involved the Revised Uniform Partnership Act.

Given the importance to the decision, here’s Judge Breyer’s discussion of these five reasons:

First, the dissolution of the firm at issue in Jewel was voluntary, while Heller’s dissolution was forced when Bank of America withdrew the firm’s line of credit. This is significant because the partners in Jewel could have, but chose not to, finish representing their clients as or on behalf of the old firm. Here, Heller lacked the financial ability to continue providing legal services to its clients, leaving clients with ongoing matters no choice but to seek new counsel and Heller Shareholders no choice but to seek new employment. Second, in Jewel, “[t]he new firms represented the clients under fee agreements entered into between the client and the old firm.” Id. at 175. Here, the clients signed new retainer agreements with the new firms. Third, in Jewel, the new firms consisted entirely of partners from the old firms: one firm with four partners had become two firms with two partners each. Here, Defendants are preexisting third-party firms that provided substantively new representation, requiring significant resources, personnel, capital, and services well beyond the capacity of either Heller or its individual Shareholders. Where in Jewel, the departed partners continued to have fiduciary duties to each other and the old firm, here, the third-party firms never owed any duty, fiduciary or otherwise, to the dissolved firm. Fourth, Jewel treated hourly fee matters and contingency fee matters as indistinguishable. Here, there are no contingency fee cases at issue. Finally, Jewel was decided in 1984 and thus applied the Uniform Partnership Act (the “UPA”) which the materially different Revised Uniform Partnership Act (the “RUPA”) has since superseded. The RUPA, which applies after 1999 to all California partnerships, allows partners to obtain “reasonable compensation” for helping to wind up partnership business, Cal. Corp. Code § 16401(h), and thus undermines the legal foundation on which Jewel rests.

RUPA, Equity, and Policy. In addition to these five key reasons, Judge Breyer expanded his analysis and concluded that legal, equitable and policy considerations all supported the decision.

  • He found the impact of RUPA on Jewel claims to be “significant” because under RUPA, the duty not to compete with the partnership ends on dissolution, unlike the continuing fiduciary duty not to take action on unfinished partnership business the Jewel court found under the old UPA. Judge Breyer also noted that the California Supreme Court has never ruled on this issue and has cited Jewel only once, in a pre-RUPA case, for an unrelated issue.
  • Turning to the equities, Judge Breyer had little trouble concluding they favored dismissal of the unfinished business claims. As a matter of equity, he stated, “it is simple enough to conclude that the firms that did the work should keep the fees” and further, since clients own the matters, goodwill is not a recognized property interest of law firms.
  • Likewise, the Court found policy considerations supported dismissal. Among other reasons, the trustee’s position would “discourage third-party firms from hiring former partners of dissolved firms and discourage third-party firms from accepting new clients formerly represented by dissolved firms.”  This “would all but force former Heller clients to retain new counsel with no connection to Heller or their matters,” contrary to “the primacy of the rights of clients over those of lawyers.” Clients should have access to a market for legal services “unencumbered by quarrelsome claims of disgruntled attorneys and their creditors.”

A Post-Heller World. It’s not an overstatement to say that the Heller decision essentially dismantles the applicability of Jewel v. Boxer to insolvent or bankrupt law firms. If upheld after any appeal and followed by other courts, the Heller decision could mark the end of California “unfinished business” claims against law firms in the non-contingency, hourly fee context. There may yet be more twists and turns in the Heller case and in other law firm bankruptcies, so stay tuned for further developments.

In A Reversal, Eighth Circuit Sitting En Banc Protects Trademark Licensee Whose Licensor Went Bankrupt

Posted in Business Bankruptcy Issues, Recent Developments

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Image courtesy of  Kazuhisa Otsubo

Trademark Licenses At Risk. I have written a number of times on the blog about the impact of bankruptcy on trademark licenses, with a special focus on the risk that trademark licensees face if their licensors file bankruptcy. Trademark licensees have no protection under Section 365(n) of the Bankruptcy Code, and legislative efforts to give that protection have stalled. As a result, if a trademark license is determined to be executory and it’s rejected by the licensor or bankruptcy trustee, the licensee could find itself without any further rights to the trademark.

Some Rays Of Hope For Licensees In Third And Seventh Circuits. A series of decisions over the past few years from various U.S. Courts of Appeals has given some hope to trademark licensees. First, in In re Exide Techs., 607 F.3d 957 (3d Cir. 2010), the Third Circuit held a trademark license that was part of a long-completed sale of assets was not executory and could not be rejected. Then in Sunbeam Prods., Inc. v. Chicago Am. Manuf., LLC, 686 F.3d 372 (7th Cir. 2012), the Seventh Circuit went much farther and held that rejection does not terminate the licensee’s rights to continue to use the trademark, refusing to follow the 1985 Fourth Circuit decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). Follow the links in the prior sentences for more details.

At First, A Setback For Licensees In Interstate Bakeries Case. Just when the Third Circuit decision was starting to give hope to trademark licensees in asset sales, the Eighth Circuit went the other way and held that a trademark license entered into as part of an asset sale was executory and could be rejected. In In re Interstate Bakeries Corp., 690 F.3d 1069 (8th Cir. 2012), a case with facts very similar to Exide, a three-judge panel of the U.S. Court of Appeals for the Eighth Circuit examined whether an exclusive license to use brands and trademarks belonging to Interstate Brands Corporation (“IBC”), which subsequently filed for bankruptcy, was an executory contract.

  • Prior to bankruptcy, IBC entered into a $20 million asset purchase agreement and license agreement with Lewis Brothers Bakeries (“LBB”), and certain baking and business operations in the Chicago area to LBB. Following IBC’s bankruptcy, LBB sought a declaratory judgment that the license agreement was not an executory contract. The bankruptcy court and district court both found the agreement executory, with unperformed obligations on both sides.
  • Although the relevant aspects of the license agreement appeared at first blush to be nearly identical to those in Exide, the Eighth Circuit panel found the license agreement in Interstate Bakeries to be materially different. Specifically, the Eighth Circuit panel found LBB’s obligation to maintain quality standards, and IBC’s obligations of notice and forbearance with regard to the trademarks, material and unperformed. As such, it held the license agreement was executory and could be rejected.
  • The Eighth Circuit panel distinguished Exide because there, “the parties had not even contemplated or discussed any quality standards. . . . Here, it cannot be argued the parties did not contemplate any quality standards, as it is an explicit provision of the License Agreement. Moreover, the plain language of the agreement provides a breach of the quality provision would be material.”

A Rehearing And A Reversal. But the story did not end there. The panel decision was split 2 to 1, and the Eighth Circuit ultimately granted a rehearing en banc. That meant all eleven of the Eighth Circuit judges would consider the case, not just the three judges on the original panel. On June 6, 2014, the full Eighth Circuit issued an 8-3 decision holding that the license agreement was no longer executory. After concluding that intervening events had not rendered the appeal moot, the Eighth Circuit held the proper focus to be on the entire transaction, not just on the license agreement:

The essence of the agreement here was the sale of IBC’s Butternut bread and Sunbeam bread business operations in specific territories, not merely the licensing of IBC’s trademark. The agreement called for LBB to pay $20 million for IBC’s assets. The parties allocated $11.88 million for tangible assets, such as real property,machinery and equipment, computers and licensed computer software, vehicles, office equipment, and inventory. They allocated another $8.12 million toward intangible assets, including the license. IBC has transferred all of the tangible assets and inventory to LBB, executed the License Agreement, and received the full $20 million purchase price from LBB.

IBC’s remaining obligations concern only one of the assets included in the sale—the license. They involve such matters as obligations of notice and forbearance with regard to the trademarks, obligations relating to maintenance and defense of the marks, and other infringement-related obligations. When considered in the context of the entire agreement, these remaining obligations are relatively minor and do not relate to the central purpose of the agreement to sell the Butternut and Sunbeam bread operations and assets to LBB in certain territories.

Unlike the three-judge panel, the full Eighth Circuit commented on the similarity of the facts to the Exide case and found the Third Circuit’s decision persuasive:

We find useful guidance on analogous facts in the Third Circuit’s decision in In re Exide. At issue there was the $135 million sale of Exide’s industrial battery business to EnerSys, which included a trademark license agreement. 607 F.3d at 960. Along with the license, Exide sold to EnerSys physical manufacturing plants, equipment, inventory, and certain items of intellectual property. Id. The Third Circuit held that Exide’s remaining obligations, which included duties to maintain quality standards, to refrain from use of the trademark outside the industrial battery business, and to indemnify EnerSys, did not “outweigh the substantial performance rendered and benefits received by EnerSys.” Id. at 963–64. The court observed that the remaining contractual obligations did not relate to the purpose of the agreement—the sale of Exide’s industrial battery business—and that the trademark license agreement was therefore not executory. Id. at 964. For similar reasons, we conclude that the License Agreement between IBC and LBB is not executory.

In a footnote, the Eighth Circuit noted the circuit split between the Fourth Circuit’s Lubrizol decision and the Seventh Circuit’s Sunbeam decision on whether rejection of a trademark license terminates the licensee’s rights to use the trademark. However, given its holding that the license agreement was not executory, the Eighth Circuit did not need to reach the rejection issue.

The Trend Continues. The full Eighth Circuit’s decision in Interstate Bakeries is yet another ray of hope for trademark licensees. It continues the recent trend of Courts of Appeals finding ways to protect trademark licensees from the harsh result of losing all rights to use a trademark via rejection. Still, unless the Sunbeam decision is adopted broadly or Congress passes one of the bills proposing to include trademarks within Section 365(n)’s protections, trademark licensees whose licensors file bankruptcy — and especially those whose licenses were granted outside of an asset sale context — are by no means out of the woods.

Applying Its Stern v. Marshall Ruling On The Power Of Bankruptcy Courts, The U.S. Supreme Court Issues A Narrow Decision In Executive Benefits Case

Posted in Business Bankruptcy Issues, Recent Developments

Supreme Court

 Image Courtesy of Mike M.S.

The Stern v. Marshall Decision. In its 2011 decision in Stern v. Marshall, decided by a 5-4 vote, the U.S. Supreme Court held that even though Congress designated certain state law counterclaims as “core” proceedings, Article III of the U.S. Constitution prohibits bankruptcy courts from finally adjudicating those claims. Stern v. Marshall left a number of questions unanswered, including the following:

  1. Is a fraudulent conveyance claim under state law or the Bankruptcy Code a “Stern claim” for which a bankruptcy court is constitutionally prohibited from entering final judgment?;
  2. Can a bankruptcy court enter a final judgment on “Stern claims” with the parties’ consent?; and
  3. Can a bankruptcy court treat a “core” Stern claim as “non-core” under 28 U.S.C. Section 157 and follow the statutory procedures for submitting proposed findings of fact and conclusions of law to the district court for de novo review, even though there appears to be a gap in the statute and it does not expressly provide for that approach?

The Decision And Appeals Below. These issues were in play in cases around the country, including the Ninth Circuit’s decision in In re Bellingham, a case that involved a bankruptcy trustee’s fraudulent conveyance claims against Executive Benefits Insurance Agency (“EBIA”) and other defendants. The trustee ultimately filed a motion for summary judgment in the bankruptcy court, which granted judgment in favor the trustee, including on the fraudulent conveyance claims. EBIA appealed to the district court, which affirmed the bankruptcy court’s decision after a de novo review of the summary judgment ruling.

  • EBIA appealed again to the Ninth Circuit and, after the Supreme Court’s Stern v. Marshall decision was issued, sought to dismiss its appeal, arguing that Article III did not permit the bankruptcy court to issue a final judgment on the fraudulent conveyance claims.
  • The Ninth Circuit denied the motion, holding that although Article III did not permit a bankruptcy court to enter final judgment on a fraudulent conveyance claim against a noncreditor without consent of the parties, EBIA had impliedly consented to the bankruptcy court’s adjudication in the case.
  • The Ninth Circuit also noted that the bankruptcy court’s judgment could be treated as its proposed findings of fact and conclusions of law under the “non-core” statutory scheme, subject to the de novo review given by the district court in the case.

When the Supreme Court granted review of the Ninth Circuit’s decision in Executive Benefits Insurance Agency v. Arkinson, many thought the Supreme Court’s decision would answer these questions. In fact, there was a palpable fear among bankruptcy professionals that the Supreme Court might hold consent of the parties to be insufficient to overcome Article III concerns, and further that the Supreme Court might limit bankruptcy court jurisdiction over fraudulent transfer claims and require their adjudication solely in the district court. Other commentators questioned whether a ruling could put the federal magistrate judges system at risk, since they too exercise jurisdiction to enter final judgments with the consent of the parties.

The Supreme Court’s Narrow Decision. However, in an unanimous 9-0 decision in Executive Benefits Insurance Agency v. Arkinson, issued on June 9, 2014 (follow link for copy of opinion), Justice Clarence Thomas, writing for the Supreme Court, reached the decision by addressing only the third question, the one involving statutory construction. In affirming the Ninth Circuit’s decision, the Supreme Court expressly “reserve[d] … for another day” a decision on the question of whether Article III permits a bankruptcy court to enter final judgment on a Stern claim with the consent of the parties. It also did not decide whether a fraudulent conveyance claim is actually a Stern claim, noting instead that because neither party contested that conclusion its opinion simply assumed, without deciding, that it was a Stern claim.

Here’s how the Supreme Court described its holding:

We hold today that when, under Stern’s reasoning, the Constitution does not permit a bankruptcy court to enter final judgment on a bankruptcy-related claim, the relevant statute nevertheless permits a bankruptcy court to issue proposed findings of fact and conclusions of law to be reviewed de novo by the district court. Because the District Court in this case conducted the de novo review that petitioner demands, we affirm the judgment of the Court of Appeals upholding the District Court’s decision.

It restated that decision another way later in the opinion:

As we explain in greater detail below, when a bankruptcy court is presented with such a claim, the proper course is to issue proposed findings of fact and conclusions of law. The district court will then review the claim de novo and enter judgment. This approach accords with the bankruptcy statute and does not implicate the constitutional defect identified by Stern.

The reason the Supreme Court held its approach “accords with the bankruptcy statute,” and there is no “statutory gap” is because 28 U.S.C. Section 157 has a severability provision:

The plain text of this severability provision closes the so-called “gap” created by Stern claims. When a court identifies a claim as a Stern claim, it has necessarily “held invalid” the “application” of §157(b)—i.e., the “core” label and its attendant procedures—to the litigant’s claim. Note following §151. In that circumstance, the statute instructs that “the remainder of th[e] Act . . . is not affected thereby.” Ibid. That remainder includes §157(c), which governs non-core proceedings. With the “core” category no longer available for the Stern claim at issue, we look to §157(c)(1) to determine whether the claim may be adjudicated as a non-core claim—specifically, whether it is “not a core proceeding” but is “otherwise related to a case under title 11.” If the claim satisfies the criteria of §157(c)(1), the bankruptcy court simply treats the claims as non-core: The bankruptcy court should hear the proceeding and submit proposed findings of fact and conclusions of law to the district court for de novo review and entry of judgment.

The Supreme Court also commented how it noted in Stern that its decision there had not meaningfully changed the division of labor between bankruptcy and district courts. Referring back to that point, the Supreme Court in Executive Benefits rejected EBIA’s argument that district courts are required to hear all Stern claims in the first instance, since such an approach would have dramatically altered the division of responsibility set by Congress.

The De Novo Review Solution. The Supreme Court did not have to reach the consent issue in this case because it concluded “that EBIA received the de novo review and entry of judgment to which it claims constitutional entitlement.” That happened when the district court on appeal reviewed de novo the bankruptcy court’s grant of summary judgment, and then the district court itself entered judgment for the trustee.

  • The Supreme Court found that here appellate review alone provided sufficient de novo review to satisfy Article III because the bankruptcy court’s conclusions of law were reviewed de novo by the district court acting as an appellate court.
  • A bankruptcy court decision to grant summary judgment on a Stern claim, at least if appealed and affirmed by a district court on appeal after a de novo review of the legal issues, should be constitutionally sufficient even without consent given Executive Benefits.  However, parties and bankruptcy courts may be uncomfortable relying on that narrow ruling given the uncertainty of a how a particular litigation may proceed.
  • Importantly, the Supreme Court did not hold that appellate review alone is sufficient de novo review of Stern claims in all procedural settings.  Appellate courts typically review de novo only a bankruptcy court’s legal conclusions, not its findings of fact, which are entitled to greater deference on appeal. In contrast, the non-core procedure under 28 U.S.C. Section 157(c)(1), in which the bankruptcy court makes only proposed findings of fact and conclusions of law, requires the district court to engage in a full de novo review of both legal and factual issues.

Where Does This Leave The Consent Issue? By leaving for another day the consent question, and by assuming but not deciding whether fraudulent conveyance claims are Stern claims, the Supreme Court resolved the Executive Benefits case on the narrowest of grounds. As in Stern, the Supreme Court once again left bankruptcy courts and parties litigating these claims with important, unanswered questions.

  • To address the consent issue, after Stern a number of bankruptcy courts adopted local rules and procedures to require parties either to make an affirmative decision indicating whether they consented to the bankruptcy court entering final judgment or implying such consent from the lack of a timely objection.
  • Although the Supreme Court did not reach the consent issue in Executive Benefits, the decision may persuade bankruptcy courts to reconsider the focus on consent.
  • The Supreme Court’s clear holding that there is no “statutory gap,” and its statement that bankruptcy courts “should” use the non-core procedure for Stern claims, may well lead bankruptcy courts to issue proposed findings of fact and conclusions of law on all Stern claims for de novo review by district courts.
  • Although the report and recommendation approach adds another layer of delay and cost for parties, and places an additional burden on already overcrowded district courts, the Supreme Court has now gone on record calling this the “proper course” for Stern claims, while technically reserving the consent issue.
  • Given this jurisprudence, more bankruptcy courts may conclude that the non-core approach is preferable to continuing down the unsettled consent path for Stern claims, although others may still test whether consent is sufficient.

Conclusion. Despite the fears of some, the Supreme Court’s decision did not take away the ability of bankruptcy courts to hear Stern claims in the first instance, reaffirming that they continue to have a role in the adjudication of these claims. While it remains to be seen how bankruptcy courts and parties will react, the Executive Benefits decision may increase the number of bankruptcy courts opting to issue reports and recommendations for de novo review by district courts, and fewer may continue to attempt to enter final judgments with consent of the parties. That said, the consent issue may yet have its day at the Supreme Court as other cases move through the bankruptcy system, so stay tuned.

Patent Reform Bill, And Its Revisions To Bankruptcy Code Section 365(n), Stalls In The Senate

Posted in Business Bankruptcy Issues, Recent Developments

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Image courtesy of Matt H. Wade

In December 2013 I wrote about the Innovation Act, H.R. 3309, a bill focused on patent infringement litigation and other patent law reforms that passed the House of Representatives on a bipartisan basis. My interest in the bill was because it would make the most sweeping changes to the treatment of intellectual property licenses in bankruptcy since the 1988 enactment of Section 365(n) of the Bankruptcy Code. Follow the link in this sentence for a full discussion of the proposed law.

Proposed Changes In The House-Passed Innovation Act. To bring you up to date, here are the four major changes the Innovation Act would make to Section 365(n)’s protections for IP licensees.

  • First, it would extend Section 365(n)’s protections, including through an amendment to Section 101(35A) of the Bankruptcy Code’s definition of intellectual property, to licenses of trademarks, service marks, and trade names.
  • Second, rejection of a trademark, service mark, or trade name license would not relieve the trustee (or presumably a debtor in possession in a Chapter 11 case) of the debtor’s contractual obligations to monitor and control the quality of a licensed product or service.
  • Third, it would expand the payments that a licensee would have to continue to make to the estate, if it elected to retain its license rights, to include not only “royalty” payments but also “other” payments under the license.
  • Fourth, it would amend Section 1522 of the Bankruptcy Code to make Section 365(n) directly applicable to Chapter 15 cases, providing that if a foreign representative rejects or repudiates an IP license, the licensee would be entitled to elect to retain its IP rights under Section 365(n).

If enacted and signed by the President, the Innovation Act’s revisions would apply as of the date of enactment to pending and future cases.

After House Passage, Action On A Senate Version. After passing the House, the Innovation Act moved to the Senate and was referred to the Senate Committee on the Judiciary. Senator Patrick Leahy, the Senate Judiciary Committee Chairman, had introduced a similar bill, S. 1720, the “Patent Transparency and Improvements Act of 2013.”  As introduced, that bill would have made many of the same changes to Section 365(n) and the Bankruptcy Code definition of intellectual property (specifically, adding in coverage of trademarks as discussed above) as in the House-passed Innovation Act. The Senate bill would have also addressed the applicability of Section 365(n) in Chapter 15 cases, but by amending a different section of Chapter 15.

The Legislation Hits A Roadblock. The Senate Judiciary Committee held a hearing on S. 1720, and a number of discussions and negotiations involving companies affected by patent litigation ensued. However, those efforts reached an impasse and on May 21, 2014, Senator Leahy announced:

We have been working for almost a year with countless stakeholders on legislation to address the problem of patent trolls who are misusing the patent system. This is a real problem facing businesses in Vermont and across the country.

Unfortunately, there has been no agreement on how to combat the scourge of patent trolls on our economy without burdening the companies and universities who rely on the patent system every day to protect their inventions.  We have heard repeated concerns that the House-passed bill went beyond the scope of addressing patent trolls, and would have severe unintended consequences on legitimate patent holders who employ thousands of Americans.

I have said all along that we needed broad bipartisan support to get a bill through the Senate. Regrettably, competing companies on both sides of this issue refused to come to agreement on how to achieve that goal.

Because there is not sufficient support behind any comprehensive deal, I am taking the patent bill off the Senate Judiciary Committee agenda.  If the stakeholders are able to reach a more targeted agreement that focuses on the problem of patent trolls, there will be a path for passage this year and I will bring it immediately to the Committee.

We can all agree that patent trolls abuse the current patent system.  I hope we are able to return to this issue this year.

Conclusion. Senator Leahy’s statement makes clear that the focus of this legislation is on patent litigation reform, not bankruptcy and IP licenses. The fate of the legislation will depend on whether the interested parties can reach agreement on those patent issues. However, the stalling of the patent legislation also means the bankruptcy provisions, at least for now, will stay on hold; it seems unlikely the bankruptcy provisions would move forward in legislation separate from the overall patent reform effort. Stay tuned, but the odds now seem considerably lower that these changes to the treatment of IP licenses in bankruptcy will be enacted.

What The U.S. Supreme Court’s Unamimous Decision In A Homestead Exemption Case Says About The Power Of Bankruptcy Courts In Business Cases

Posted in Business Bankruptcy Issues, Recent Developments

 

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It seems that most bankruptcy decisions by the U.S. Supreme Court involve individual debtors, and the Supreme Court’s latest opinion is no exception. Even though the decision is not in a business bankruptcy case, it examines the bankruptcy court’s powers under Section 105(a) of the Bankruptcy Code. Section 105(a) is commonly invoked in business bankruptcy cases to prevent business disruption through “first day” motions and orders, as part of a Section 363 sale of assets free and clear of liens, and in granting other relief to facilitate a debtor’s reorganization. This fact makes the Supreme Court’s most recent decision, discussed below, of interest for both individual and business bankruptcy cases.

The Key Holding: Exempt Property Really Is Exempt. In an unamimous decision issued on Tuesday, March 4, 2014 in Law v. Siegel (click on the link for a copy of the opinion), the Supreme Court held that a bankruptcy court cannot surcharge a debtor’s homestead exemption to pay for the Chapter 7 trustee’s administrative expenses, even if those expenses were incurred as a result of the debtor’s fraudulent misrepresentations.

  • The bankruptcy court had surcharged the debtor’s $75,000 California homestead exemption to cover the trustee’s fees and costs, but the Supreme Court reversed. It held that Bankruptcy Code Section 522(k)’s explicit language that a debtor’s exempt property “is not liable for payment of any administrative expense” (other than in inapplicable and specific circumstances detailed in that section), precludes a bankruptcy court from invoking either its authority under Section 105(a) to issue orders to “carry out” the provisions of the Bankruptcy Code, or its inherent sanctioning powers, to surcharge the debtor’s homestead exemption.
  • In short, where Congress has declared a debtor’s exempt property off limits, a bankruptcy court cannot not use Section 105(a) to override that specific statutory limitation.

Implications For Business Bankruptcy Cases?  As a business bankruptcy blog, the focus here is on whether the Supreme Court’s decision tells us anything about a bankruptcy court’s powers outside the exempt property context (especially since corporate debtors cannot claim exemptions). At first blush, the Supreme Court’s decision is, of course, a direct rejection of the use of Section 105(a), at least to impose a surcharge on exempt property. But does the decision otherwise weaken a bankruptcy court’s powers under Section 105(a) and its inherent powers?

An insight into the answer seems to come at the very end of the decision. After acknowledging that its holding imposes a heavy financial burden on the Chapter 7 trustee, and could lead to inequitable results in other cases, the Supreme Court addressed what else a bankruptcy court could do to respond to a debtor’s misconduct:

Our decision today does not denude bankruptcy courts of the essential “authority to respond to debtor misconduct with meaningful sanctions.” Brief for United States as Amicus Curiae 17. There is ample authority to deny the dishonest debtor a discharge. See §727(a)(2)–(6). (That sanction lacks bite here, since by reason of a postpetition settlement between Siegel and Law’s major creditor, Law has no debts left to discharge; but that will not often be the case.) In addition, Federal Rule of Bankruptcy Pro­cedure 9011—bankruptcy’s analogue to Civil Rule 11—authorizes the court to impose sanctions for bad-faith litigation conduct, which may include “an order directing payment. . . of some or all of the reasonable attorneys’ fees and other expenses incurred as a direct result of the viola­tion.” Fed. Rule Bkrtcy. Proc. 9011(c)(2). The court may also possess further sanctioning authority under either §105(a) or its inherent powers. Cf. Chambers, 501 U. S., at 45–49. And because it arises postpetition, a bankruptcy court’s monetary sanction survives the bankruptcy case and is thereafter enforceable through the normal proce­dures for collecting money judgments. See §727(b). Fraud­ulent conduct in a bankruptcy case may also subject a debtor to criminal prosecution under 18 U. S. C. §152, which carries a maximum penalty of five years’ imprisonment.

But whatever other sanctions a bankruptcy court may impose on a dishonest debtor, it may not contravene express provisions of the Bankruptcy Code by ordering that the debtor’s exempt property be used to pay debts and expenses for which that property is not liable under the Code.

Conclusion. The Supreme Court’s discussion of the range of actions a bankruptcy court could take to address debtor misconduct helped narrow the decision to situations where a bankruptcy court uses Section 105(a) in contravention of express statutory language. The Supreme Court’s effort to make clear that, outside of those settings, bankruptcy courts possess a broad range of authority, specifically including under Section 105(a), Bankruptcy Rule 9011, and its inherent powers, seems to reinforce, rather than weaken, the power of bankruptcy courts. That makes this decision important for individual — and business — bankruptcy cases.

Image courtesy of Flickr by Kyle Rush

Cooley’s New Absolute Priority Blog Has Launched

Posted in Business Bankruptcy Issues, Recent Developments

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I’m pleased to let you know that the Corporate Restructuring and Bankruptcy Group at Cooley LLP, of which I am a member, has just launched the new Absolute Priority blog, the new format going forward for our group’s popular Absolute Priority newsletter. Follow the link in the prior sentence to visit the new Absolute Priority blog and, while there, be sure to enter your email address at the “Follow Blog via Email” sign-up to receive notification emails when new posts are added.

I hope you’ll enjoy the new Absolute Priority blog, as well as this In The (Red) blog, to which you can also subscribe using the links on the right side of the page.

Winter 2014 Edition Of Bankruptcy Resource Now Available

Posted in Business Bankruptcy Issues, Recent Developments

I hope you had a wonderful holiday season and Happy New Year everyone.

To start the new year off, the Winter 2014 edition of the Absolute Priority newsletter, published by the Bankruptcy & Restructuring group at Cooley LLP, of which I am a member, has been released. The newsletter gives updates on current developments and trends in the bankruptcy and workout area. Follow the links in this sentence to access a copy of the newsletter

This edition of Absolute Priority covers a range of cutting edge topics, including:

  • An Eleventh Circuit ruling that indirect benefits from a Subchapter S election can constitute reasonably equivalent value for fraudulent transfer purposes;
  • The Ninth Circuit’s decision permitting recharacterization claims; and
  • A recent Seventh Circuit decision on the validity of a cross-collateralized real estate lien.

It also reports on some of our recent representations, including for official committees of unsecured creditors in Chapter 11 cases involving major retailers and others, and our work for Chapter 11 debtors. Recent committee cases include Mervyn’s Holdings, Appleseed’s Intermediate Holdings, and Underground Energy, among others. Recent debtor representations include Cylex (now Immunology Partners), IntraOp Medical (now MC Liquidation), and Nirvanix.

I hope you find the latest edition of Absolute Priority to be of interest. Please note that this will be the final issue in newsletter format, as soon our group will be providing future insights through a new Absolute Priority blog, in addition to this In The (Red) blog. Stay tuned for more details.