Recent Developments

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Business Bankruptcy Issues Recent Developments

A Second District Court Decides Whether A Trademark License Can Be Assumed In Bankruptcy

Once again, a district court has faced the issue of whether a non-exclusive trademark license can be assumed by a debtor in possession. Before the November 2005 decision in In re: N.C.P. Marketing Group, Inc., 337 B.R. 230 (D.Nev. 2005), no court had directly addressed that question. The decision in the N.C.P. Marketing case, now on appeal to the Ninth Circuit, held that trademark licenses are personal and nonassignable, absent a provision in the trademark license to the contrary, and in a hypothetical test jurisdiction such as the Ninth Circuit, they cannot be assumed by the debtor in possession. For a more detailed discussion on the N.C.P. Marketing case, you may find this post of interest. For an analysis of some recent trends on the broader topic of assumption of IP licenses, try this post.

The Wellington Vision Case. Earlier this year, a second district court, this time the U.S. District Court for the Southern District of Florida, faced the same question in an appeal in the In re Wellington Vision, Inc. Chapter 11 bankruptcy case.

  • Pearle Vision sought relief from the automatic stay to terminate a franchise agreement with Wellington Vision, arguing that Wellington could not assume the agreement because it Included a non-exclusive license of Pearle Vision trademarks.
  • The U.S. Bankruptcy Court for the Southern District of Florida granted the motion for stay relief by this two-page order, holding that the inclusion in the franchise agreement of a trademark license made the agreement, under federal trademark law, non-assignable absent consent by Pearle Vision.

Appeal To The District Court. Wellington Vision filed an appeal from the Bankruptcy Court’s decision.

  • In its opening brief, Wellington argued that (1) Pearle Vision had failed to establish that the franchise agreement included a trademark license, (2) a provision in the franchise agreement allowing for assignments on consent that cannot be unreasonably withheld meant that the parties had opted out of applicable law, and (3) Section 365(c)(1) of the Bankruptcy Code only prohibits assumption or assignment by a trustee, not by a debtor in possession, citing the Footstar case.
  • Pearle Vision argued in its answer brief that "applicable law" is the federal Lanham Act, which makes trademark licenses personal and non-assignable, and that Section 365(c)(1) creates a hypothetical test and precludes assignment or assumption of the license.
  • Wellington’s reply brief asserted that the District Court should not apply Section 365(c)(1) to debtors in possession and further that it should hold that this license was assignable by its terms.

The District Court’s Decision On Appeal. On February 20, 2007, Judge Alan S. Gold of the U.S. District Court for the Southern District of Florida affirmed the Bankruptcy Court’s decision in this 14-page decision. The District Court first held that the franchise agreement expressly included a non-exclusive license to certain Pearle Vision trademarks, making the Lanham Act the "applicable law" to be considered under Section 365(c)(1). It then held that the agreement’s provisions contemplating assignment under certain conditions did not constitute consent to any specific assignment or an "opt out" of the Lanham Act’s general restrictions on assignment, distinguishing In re Quantegy, 326 B.R. 467 (Bankr. M.D. Ala. 2005), relied on by Wellington. Finally, the District Court held that Section 365(c)(1) did apply to debtors in possession and not just to trustees, citing the Eleventh Circuit’s decision in City of Jamestown v. James Cable Partners, L.P., 27 F.3d 534 (11th Cir. 1994).

No Further Appeal Has Been Filed. Unlike the N.C.P. Marketing case, the District Court’s decision in this case will not be appealed. While the appeal was pending, the Wellington case was converted to a Chapter 7 case. Also, within the past two months litigation between Pearle, Wellington, and a guarantor of certain debt owed to Pearle was settled, resolving the issues decided by the District Court.

Trademark Owners Win Another One. Although it did not cite the N.C.P. Marketing decision, the Wellington Vision court becomes only the second district court to address the assumability of trademark licenses — and the second to hold that they are not assumable when the hypothetical test applies. This is more good news for trademark owners, who typically want as much control as possible over licenses to their marks, but bad news for debtors, who face the prospect of losing valuable trademark licenses (and franchise agreements including them) if they file bankruptcy. Stay tuned for more developments on this issue, including the Ninth Circuit’s decision in N.C.P. Marketing, which is likely still months away.

Special thanks to Warren Agin of the Tech Bankruptcy blog, whose post entitled The Descent Into Darkness Continues, first discussed the Wellington Vision case. The title of that post also gives you a sense of how many bankruptcy lawyers feel about the hypothetical test, its application to IP licenses, and its impact on debtors. 

Business Bankruptcy Issues Recent Developments

Are We In A Global Financial Bubble?

The San Francisco Business Times reports in a new article that the CEOs of Bank of America and GMO, a global investment management firm, have both commented recently about what they see going on in the financial and asset markets. Their views are similar to those expressed by the CEO of a major private equity fund, as reported here.

The San Francisco Business Times article quotes Ken Lewis of Bank of America as stating, "We need a little more sanity in a period in which everyone feels invincible and thinks this time is different," and "[w]e are close to a time when we’ll look back and say we did some stupid things." A Bloomberg article on his remarks can be found here.

Jeremy Grantham, CEO of GMO, went further and said he believes we are in the first "global bubble" in everything from stocks to junk bonds to land in Panama. His definition of a bubble is also interesting: "Perfect conditions create very strong ‘animal spirits’ reflected statistically in low risk premium," and "[w]idely available cheap credit offers investors the opportunity to act on their optimism." A version of his comments, published in the Financial Times and available courtesy of MSNBC.com, can be found here.

I can vividly recall a comment made by a highly respected senior corporate attorney shortly before the dot com bubble burst in early 2000. Although he didn’t use the term bubble, his description of the way venture funds were rapidly investing in companies and how, in turn, the public equity markets were snapping up shares in IPOs, still rings in my ears: "In thirty years of practice, I have never seen anything like it."

Jeremy Grantham of GMO reminds us that "Every bubble has always burst." It’s still hard to tell whether this period is a really a bubble or something short of it, and the recent comments from CEOs and others may be aimed at reducing some of the froth in various asset classes. However, if we actually are in another bubble there’s little reason to think the outcome will be "different this time." If so, at some point we may see a new wave of restructurings and Chapter 11 filings.

Business Bankruptcy Issues Recent Developments

Third Circuit Shoots Down Plan Confirmation, Finding Improper Gerrymandering

In an interesting decision issued last month in a case called In re Machne Manachem, Inc., the Third Circuit upheld a district court’s decision to reverse confirmation of a Chapter 11 plan of reorganization. The decision stemmed from steps taken to obtain votes required for approval of the plan. Before discussing the details, a bit of background on bankruptcy plans and the rules governing voting is in order.

Classes And Plans Of Reorganization. Bankruptcy plans must classify creditors and equity holders into various classes, usually based on the type of debt or equity security they hold or on other characteristics of their claims or interests. Each secured creditor is typically put in a separate class or subclass, bondholders may be put in a separate class based on the bond issue involved, general unsecured creditors may be grouped together in one class, and the claims held by insiders are occasionally put in a separate class.

Voting Requirements For Plans. The Bankruptcy Code spells out the voting rules for Chapter 11 plans of reorganization.

  • Under Section 1129(a)(10) of the Bankruptcy Code, at least one "impaired" class must vote to accept a plan. In the bankruptcy world, "impaired" means that under the plan the holder of the claim or interest will receive treatment that is different (usually worse) than what it would get outside of bankruptcy. This may involve stretching out repayment terms over time, paying less than 100 cents on the dollar, or canceling all shares of prepetition stock.
  • To accept a plan, the tally of votes from the impaired class must meet or exceed two thresholds. Two-thirds in dollar amount and a majority in number of those creditors voting must accept the plan.
  • If these tests are satisfied, as happened in the Third Circuit case, and if other requirements are met, the debtor may be able to "cram down" the plan on the rest of the creditor body, even if other creditors voted to reject the plan. 

A Case Of Gerrymandering. In this case, the plan got the required votes from the impaired class. So what prompted the Court of Appeals to throw out the plan? In short, the Court found that by purchasing a select set of impaired claims, an insider of the debtor gerrymandered the vote in favor of the debtor’s plan. The Court ruled that the insider’s purchase of four claims in the only impaired class that accepted the plan was done to win the vote of that class. Once they were purchased, those claims were shifted out of the key class and into another class where their votes would not matter. This conduct, the Court held, was improper and "undermined the critical confirmation requirements of the bankruptcy code."

  • Although there was little evidence either way, the Court seem concerned that the vote in that one critical accepting class — 7 claims accepting and 4 claims rejecting — could have ended up as 7 claims accepting and 8 claims rejecting if the four purchased claims had stayed in the original class.
  • The Court also found troubling that the purchased claims received less than 100 cents on the dollar, which was the treatment the proposed plan provided for the rest of the creditors in the key class.

Conclusion. Classifying claims into classes for Chapter 11 plans and the voting process are critical aspects of the reorganization process in a business bankruptcy case.  From time to time objecting creditors may accuse the debtor or other plan proponent of gerrymandering those classes to win confirmation, but when the Third Circuit issues a decision finding that improper gerrymandering actually took place, it’s a case worth reading.  Special thanks to the Delaware Business Bankruptcy Report for first posting on the case.

Business Bankruptcy Issues Recent Developments

A Debt Bubble In Private Equity Deals?

The New York Times DealBook blog has another interesting post on the debt being used to finance private equity deals. This one is entitled "Is Private Equity Riding A Debt Bubble?" It discusses a recent article in the Boston Globe which, among other things, quotes the CEO of a major private equity firm as using the term "debt bubble" to describe the current situation in the debt market.

The Boston Globe article points to low interest rates, large loans relative to the acquired company’s cash flow, and the lack of covenants — sometimes known as "covenant lite" loans — as driving the phenomenon. Some deals are also being structured with so-called toggle notes, giving the borrower the option to make "payment in kind" or PIK payments — additional debt instead of cash — although at a higher interest rate. The absence of significant covenants led the quoted CEO to ask, "How do you default?" 

This DealBook post follows one from last week, reported here, discussing the rising risk level of the debt behind private equity deals. If these generous lending terms are putting us in a "debt bubble," would an economic hard landing burst the bubble and lead to even more defaults, restructurings, and bankruptcies? Time will tell. 

Business Bankruptcy Issues Recent Developments

Are Risk Levels Rising For The Debt That’s Financing Private Equity Deals?

The New York Times DealBook blog has an interesting post about the risks posed by all the debt that helps fund the many private equity buyouts these days. It points to two articles in the UK press on the topic.

The first article, in the Financial Times, discusses comments by Larry Fink, the CEO of BlackRock, about how increasing levels of debt, lowered risk premiums, and less restrictive lending standards in connection with today’s private equity deals may end up creating "tomorrow’s problem." A major downturn in the economy could transform buyout debt into distressed debt.

The second article, in The Guardian, reports on the Bank of England’s warning about "how quickly credit quality can deteriorate following a period of lax credit standards." Sir John Gieve, one of the Bank of England’s deputy governors, is quoted as saying that the "rapid growth in credit risk transfer markets is also making more participants dependent on continuous market liquidity and could amplify the impact of a sharp reversal in credit spreads from their current low levels."

In addition, an increasing amount of corporate debt now involves second lien loans, and out-of-court restructurings and bankruptcy cases could be noticeably more complex.  Although neither article suggests that defaults are about to spike, the perspectives offered about how quickly that could change — if economic conditions turn for the worse — makes for interesting reading. 

Business Bankruptcy Issues Recent Developments

In Important New Ruling, New York Bankruptcy Court Applies Prior Lien Defense To Post-BAPCPA Reclamation Claims

On Thursday, April 19, 2007, in perhaps only the second decision on reclamation since the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) took effect in October 2005, Judge Burton R. Lifland of the U.S. Bankruptcy Court for the Southern District of New York issued this Memorandum Decision in the In re Dana Corporation Chapter 11 bankruptcy case. Employing an analysis similar to that of Judge Sontchi in his January 2007 decision in In re Advanced Marketing Services, Inc. (discussed in this post), Judge Lifland valued all pending reclamation claims in the Dana Corporation case at zero, effectively denying them in their entirety.

A Quick Primer On Reclamation Under BAPCPA. Section 546(c) of the Bankruptcy Code, as amended by BAPCPA, gives vendors the ability to assert a reclamation claim for goods received by a debtor in the 45 days prior to the bankruptcy filing. In addition to extending the reclamation period to 45 days, BAPCPA also added a provision in Section 546(c) making reclamation claims "subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof." This quoted language refers to a secured creditor with a prior senior lien in the same goods, a defense to reclamation often referred to as the "Prior Lien Defense." (For more details on reclamation claims, both before and after a bankruptcy is filed, you may find this earlier post on reclamation of interest.)

The Reclamation Claims Process. As is typical in large Chapter 11 cases, a reclamation procedure was established in the Dana Corporation case. After setting a deadline for the filing of reclamation claims, the following events unfolded:

  • As debtor and debtor in possession, Dana Corporation filed a motion seeking bifurcation of the Prior Lien Defense from the more fact-based defenses it also intended to advance.
  • The Bankruptcy Court granted the motion and entered this bifurcation order, which separated out the Prior Lien Defense for discovery, briefing, and decision while staying discovery and other efforts relating to the remaining defenses.
  • The debtor then filed an initial brief on the Prior Lien Defense and related arguments, asserting that the scores of reclamation claims filed by creditors all were "subject to" pre-existing liens on the goods in question, rendering the reclamation claims valueless. Relying on the pre-BAPCPA case of In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003), the debtor argued that the use of DIP financing with liens on the goods in question to satisfy prepetition loans meant that those goods were effectively disposed of, were not subject to reclamation, and that reclamation claims based on them were valueless.
  • Many reclamation claimants filed objections to the debtor’s motion (this objection is representative of the types of arguments advanced). They contended that reclamation claims are valueless only if the goods sought to be reclaimed are actually used to pay the lien of the secured creditor to which they are "subject." Relying on In re Phar-Mor, Inc., 301 B.R. 482, 497 (Bankr.N.D. Ohio 2003), amended on rehearing, 2003 Bankr. LEXIS 2009 (Bankr.N.D.Ohio Dec. 18, 2003), they argued that the prepetition loans were repaid with funds from the DIP loans, not from liquidation of the goods subject to the reclamation claims.
  • The debtor then filed this reply brief, again arguing that Dairy Mart is still good law and that its principles made all reclamation claims valueless in this case.

The Dana Corporation Decision. In his 21-page decision, Judge Lifland made two important rulings. First, he addressed whether amended Section 546(c) creates a new federal common law of reclamation or whether it still relies on the Uniform Commercial Code and other state law:

The Reclamation Claimants contend that the deletion of the reference to state law in the amended section 546(c) no longer incorporates the state law right of reclamation, and instead creates a brand new federal bankruptcy law right. I disagree.

*           *           *

It is not a section dedicated to granting an independent federal right of reclamation nor does it create a coherent comprehensive federal scheme for reclamation. First, Congress did not use the language of creation – Congress did not say that “a seller may reclaim goods when….”

*          *          *

Moreover, if amended section 546(c) was a new federal reclamation right arising under the Bankruptcy Code, it would not be subject to the avoiding powers. [footnote omitted]

Second, having concluded that amended Section 546(c) did not supplant existing reclamation law, Judge Lifland examined Phar-Mor, Dairy Mart, and related case law and ruled that the Prior Lien Defense made the reclamation claims valueless in this case:

Here, the prepetition collateral, including the reclaimed goods, was subject to the Prepetition Lien. Pursuant to the Interim DIP Order, the Debtors were authorized to use the Prepetition Lenders’ cash collateral, with the Replacement Lien providing a replacement security interest in all of the Debtors collateral subject to the DIP Lien, including the prepetition collateral and the proceeds thereof. The DIP Lien granted to the DIP Lenders pursuant to the Interim DIP Order and the Final DIP Order, provided a security interest in, and lien upon, all of the collateral constituting the prepetition collateral. Thus the lien chain continued unbroken. Cf. Dairy Mart, 302 B.R. at 184 (holding that the transaction of releasing the prepetition lien and simultaneously granting the lien to the post-petition lender, must be viewed as an integrated transaction). The grant of the DIP Lien was a necessary condition of the DIP Lenders’ agreement to enter into the DIP Facility. Pursuant to the Final DIP Order, the Prepetition Indebtedness was refinanced and paid off using the proceeds of the DIP Facility on the payoff date. Because the reclaimed goods or the proceeds thereof were either liquidated in satisfaction of the Prepetition Indebtedness or pledged to the DIP Lenders pursuant to the DIP Facility, the reclaimed goods effectively were disposed as part of the March 2006 repayment of the Prepetition Credit Facility. Accordingly, the Reclamation Claims are valueless as the goods remained subject to the Prior Lien Defense.

Recognizing Another BAPCPA Change: Section 503(b)(9)’s New Administrative Claim. Although the Bankruptcy Court was considering only BAPCPA’s amended Section 546(c) and reclamation claims, the decision makes several comments about the impact of another of BAPCPA’s changes, the new "20 day goods" administrative claim. (A February 2007 update post described the first few decisions on this new Section 503(b)(9) administrative claim.) These include the following: 

The issues before the Court today relate solely to the Prior Lien Defense to reclamation rights under section 546(c) of the Bankruptcy Code and not to the rights to an administrative expense under the newly enacted section 503(b)(9) of the Bankruptcy Code. This new provision presents other issues concerning, inter alia, the valuing of the subject goods; what constitutes the actual receipt of the goods; how is the claim asserted; when is it to be paid; is it subject to the claims processing and omnibus bar date orders, etc.? These issues will not, and need not, be parsed here. Suffice it to say that in light of the section 503(b)(9) amendment, section 546(c) is no longer an exclusive remedy for a prepetition seller.

*         *          *

In addition, amended 546(c) provides for an administrative claim: "If a seller of goods fails to provide notice in the manner described in paragraph (1), the seller still may assert the rights contained in section 503(b)(9)." 11 U.S.C. § 546(c)(2). New section 503(b)(9) in turn allows the seller an administrative expense claim equal to "the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business." 11 U.S.C. § 503(b)(9). There is no shortage of commentary on the interplay of sections 503(b)(9) and 546(c).5

[Footnote 5]

With the introduction of section 503(b)(9) priority, reclamation claims under amended section 546(c) have decreased importance because goods delivered to a debtor in the 20 days prior to bankruptcy will have automatic priority. Thus, reclamation rights are now mainly beneficial for goods delivered in the 21 to 45 days prior to the bankruptcy filing under amended section 546(c). However, with the expansion of the reclamation period, the likelihood of early administrative insolvency will increase, and debtor companies will need greater financial resources to reorganize. See Charles J. Shaw and Brent Weisenberg, Effect of a Preexisting Security Interest in the Debtor’s Inventory on the Rights of Reclamation Creditors, 2005 Norton Ann. Surv. Of Bankr. Law Part I §15 (Sept. 2006) (hereinafter “Norton Survey”).

Where Does This Decision Leave Creditors And Debtors? While valuing all reclamation claims at zero, Judge Lifland was careful to mention the existence of the new administrative claim for goods delivered to the debtor in the 20 days prior to the bankruptcy. This comment is significant and reveals how BAPCPA has changed the old reclamation equation. While the jury is certainly still out, the early post-BAPCPA reclamation decisions in Advanced Marketing Services (Delaware) and Dana Corporation (Southern District of New York) suggest that creditors may have even more difficulty establishing reclamation claims. If so, instead of reclamation, the new 20 day goods administrative claim may turn out to be the more valuable right for creditors — and the more costly obligation for debtors — in this post-BAPCPA world.

Business Bankruptcy Issues Recent Developments

Scotia Pacific Court Rules On Motion To Compel Group Of Hedge Funds To Disclose Their Trading Details

In February and March of this year, Judge Allan L. Gropper of the U.S. Bankruptcy Court for the Southern District of New York, presiding over the Northwest Airlines Chapter 11 case, required an ad hoc committee of hedge funds and other stockholders to disclose publicly full details of their trades in Northwest Airlines claims and stock. This was big news because hedge funds and other distressed debt investors carefully guard their trading data. The decision raised questions about whether these very active parties would continue to form ad hoc committees, choose to act independently, or limit their participation in bankruptcy cases altogether.

The Big Question: Would Other Courts Follow Northwest Airlines? As with most new decisions of note, this one had many people wondering whether other courts would follow it and require ad hoc committees to make such disclosures. This week we got the first answer to that question, albeit in a somewhat different context, in the Scotia Pacific Company LLC (Scopac) Chapter 11 case pending in Corpus Christi, Texas. The Scopac court’s answer: not in its case. Keep reading below to see how the court got to that decision.

A Bit Of Background. First, for those new to the disclosure issue, you can read more about it in a series of earlier posts on this blog (here, here, here, here, and here). If you follow the links in this sentence you can also find copies of Judge Gropper’s first decision requiring the disclosure and second decision refusing to allow the information to be filed under seal. Both decisions were based on Federal Rule of Bankruptcy Procedure 2019(a). As a reminder, here’s the key part of Rule 2019(a):

[E]very entity or committee representing more than one creditor or equity security holder . . .  shall file a verified statement setting forth (1) the name and address of the creditor or equity security holder; (2) the nature and amount of the claim or interest and the time of acquisition thereof unless it is alleged to have been acquired more than one year prior to the filing of the petition; (3) a recital of the pertinent facts and circumstances in connection with the employment of the entity . . . ; and (4) . . . the amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof.

Scopac’s Rule 2019 Motion. With that background, here’s the Scopac disclosure story. Not long after the Northwest Airlines decisions, Scopac filed a motion to compel an Ad Hoc Group Of Timber Noteholders (which originally called itself an Ad Hoc Committee and now refers to itself as the Noteholder Group) to file an amended version of its previously filed Rule 2019 statement. Relying on the Northwest Airlines decisions, Scopac argued that the Noteholder Group should be required to file detailed information about the amounts of the claims or stock owned by the Group’s members, when they acquired it, how much they paid for it, and when they sold or otherwise disposed of any of their holdings.

The Noteholder Group’s Objection. The Noteholder Group objected to the motion, arguing that it was merely a group of noteholders and not a "committee" as that term is used in Rule 2019. Specifically, it said that it didn’t represent or purport to represent any noteholders beyond those who were already members of the Noteholder Group. The Noteholder Group also contended that, even if it were a committee, the purpose of the rule is to protect others in the class it represents and here any non-member noteholders were welcome to join the group directly.

Friends Of The Court Join In. As they had in the Northwest Airlines case, the Securities Industry and Financial Markets Association (SIFMA) and the Loan Syndications and Trading Association (LSTA) filed an amici curiae "friend of the court" brief in opposition to the Scopac Rule 2019 motion. They argued that forcing disclosure of trading details would have a detrimental impact on the market for the debt and securities of distressed companies and the willingness and ability of sophisticated parties to participate in Chapter 11 cases.

Scopac’s Reply. Scopac filed this reply arguing that the Noteholder Group, which originally called itself an "Ad Hoc Committee" and only began to describe itself as an informal "group" after the motion was filed, was a Rule 2019(a) committee and should be compelled to make additional disclosure. Scopac also argued that the Noteholder Group was acting as a representative and thus fit squarely within the rule’s requirements.

The Scopac Court’s Rule 2019 Order. On Wednesday, April 18, 2007, Judge Richard S. Schmidt of the U.S. Bankruptcy Court for the Southern District of Texas issued this order denying Scopac’s motion to compel disclosure of the details of trades in Scopac’s secured timber notes. In his two-page order, Judge Schmidt ruled that the Noteholder Group was not a "committee" within the meaning of Rule 2019 and, as such, the disclosure requirements of that rule did not apply. The DealBook blog on the New York Times website reported on the decision here.

What’s Next? The Scopac decision represents a step back from the Rule 2019 view taken by the Northwest Airlines court, but for at least two reasons the issue remains far from settled. First, the Noteholder Group in Scopac successfully argued that it was not a committee at all because it didn’t represent anyone other than its own members. This apparently persuaded the Scopac court to draw a distinction between the Noteholder Group and the Ad Hoc Committee in Northwest Airlines. It’s unclear whether other courts would do the same. Second, many more large Chapter 11 cases are filed in the Southern District of New York than in Texas these days. As a result, Judge Gropper’s decision may have a bigger impact on future cases than the Scopac decision. That said, we’ll have to wait for additional cases to see which of these two approaches courts find more consistent with the language and purpose of Rule 2019.