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Business Bankruptcy Issues

Bankruptcy Asset Sales: What Parties With Contracts Should Watch For

In many corporate bankruptcy cases, the debtor will use the bankruptcy process to sell its assets and to assume and assign valuable leases, executory contracts, and licenses (see earlier posts on what happens to leases in bankruptcy, to executory contracts, and to intellectual property licenses, a special type of executory contract). 

This post discusses some mechanics of the bankruptcy sale process and points out how parties to executory contracts and leases can protect their rights. (A discussion of the sale process from the buyer’s perspective can be found here.)

The Section 363 sale.  A bankruptcy asset sale often will happen in the first few weeks or months of a Chapter 11 case, rather than as part of a plan of reorganization. Frequently this will involve a sale of all or substantially all of a debtor’s business as a going concern. You may hear the sale referred to as a "Section 363 sale" because Section 363 is the key Bankruptcy Code section that governs a debtor’s sale of assets in bankruptcy. Regardless of what is being sold, the debtor must seek bankruptcy court approval of the sale and of any effort to transfer executory contracts, licenses, and leases to the buyer. 

Sales "free and clear" of liens. When the debtor files a motion seeking to sell its assets, it usually will ask to do so free and clear of liens. The term "lien" includes everything from UCC security interests filed by banks or other secured lenders taking the debtor’s assets as collateral for loans to judgment and other types of liens. In a Section 363 sale, a debtor may propose to sell the assets and hold the sale proceeds in a separate account, with the secured creditors’ liens being transferred over to those funds. Debtors ask for authority to sell the assets "free and clear" of liens because the buyer wants clear title to the assets, unencumbered with any of the debtor’s old debts and liens.

Motion to assume and assign executory contracts and leases. The debtor will typically file another motion (or may combine it with the motion to sell free and clear) seeking authority to assume and assign to the buyer certain executory contracts and leases.  If you are a party to an executory contract or lease, you should follow the sale process closely because your rights could well be affected. 

  • The debtor will likely send out a notice to parties to executory contracts and to landlords with a list of the contracts and leases proposed to be assumed and assigned. This is a very important document and you or your counsel should review every page carefully. 
  • The notice typically will list the amount the debtor proposes to pay to “cure” any defaults. The debtor must cure any defaults in cash before the contract or lease can be assumed and assigned to the buyer. Very often the notice will indicate that the proposed cure amount for some contracts or leases is zero or it may leave the amount blank with an asterisk stating that the debtor believes that no cure amount is owed. 
  • Here’s an example of a notice, with a fairly typical multi-page chart listing scores of contracts to be assumed and assigned as part of the sale and indicating proposed cure amounts. 

Scream or die. This isn’t a warning in a horror film but a phrase bankruptcy lawyers have coined to describe a creditor’s requirement to file an objection by the stated deadline or face the loss of your rights. (You have to admit it’s catchy.) To put it in less vivid terms, if you want to object (1) to the assignment of your executory contract, license, or lease at all, (2) to its assignment to the particular buyer proposed, or (3) even to the amount proposed to be paid to cure defaults, you have to file a written objection by the deadline listed in the notice. If you don’t, the debtor will ask the bankruptcy court for an order approving the transfer of your contract, license, or lease, and that may well involve no cure payment at all. Because bankruptcy cases move quickly by necessity, "screaming" after the deadline will generally be too late.

Got counsel?  If you have an important executory contract, intellectual property license, or commercial lease with a debtor, having your counsel monitor the bankruptcy case and review any sale motions and assumption and assignment notices is the best way to protect your rights. Otherwise, you may miss an opportunity to receive a cure payment, to object to an assignment of an intellectual property license, or otherwise to exercise your rights in the bankruptcy case.

Business Bankruptcy Issues

Doing Business With A Customer In Bankruptcy: What You Need To Know

An issue that comes up for creditors when a customer files bankruptcy is whether to keep doing business or end the relationship. Since debtors usually cannot survive without at least some level of trade support, generally they reach out to suppliers in an attempt to obtain trade terms, or at least a steady supply of goods, after a Chapter 11 bankruptcy is filed.  Often they put information about doing business in light of the bankruptcy (see this example from Delta Airlines) on a restructuring website or send out written communications to suppliers.

This post looks at the issue from the creditor’s perspective. When a smaller customer files bankruptcy the "keep doing business" question is less critical, and the bankruptcy filing may just be the final straw that leads you to want to stop selling or providing services to the customer.  When one of your bigger customers files bankruptcy, the stakes go up — often way up.  In either case, it’s important to know the ground rules about doing business with a bankrupt customer.

Administrative claim for post-bankruptcy sales. In general, if the bankrupt customer is a Chapter 11 debtor in possession, it is legally permitted to pay for post-petition (post-bankruptcy filing) purchases of goods and services in the ordinary course of business. Such amounts are generally accorded administrative claim status, with priority over unsecured and certain other claims, and the debtor is authorized to pay them currently. (Chapter 7 trustees usually close a business down and do not place further orders.)

Make sure you have an administrative claim. The standard for allowance of administrative claims requires proof of the necessity and the value to the estate of the goods or services.  While this usually is the amount set forth in a contract or purchase order, to avoid any dispute it’s best to reach a clear understanding with the debtor (or a bankruptcy trustee in the rarer instances when a Chapter 11 or Chapter 7 trustee is purchasing goods or services) before providing post-petition goods or services. Moreover, if there’s any chance that your transaction would not be considered an "ordinary course" transaction, for example if it’s an unusually large purchase or on unusual terms, you should consider seeking bankruptcy court approval to make sure the transaction is authorized and that your rights are protected.

Be careful of the executory contract twist. Your dealings with the debtor post-petition may also depend on the nature of your pre-petition relationship. 

  • If you have sold products through separate purchase orders or individual transactions without an overarching contract (see earlier post for a fuller discussion of such executory contracts) governing the relationship, generally you may choose whether to continue dealing with the debtor post-petition and on what terms you do so (e.g., whether to require cash in advance or continue with trade credit terms). If you have unpaid amounts based on your pre-petition transactions with the debtor, that claim would be treated like other unsecured claims separate from any post-petition claim. 
  • If you and the debtor are parties to a pre-petition contract that is executory (meaning both you and the debtor have material obligations to continue to perform), you cannot automatically stop performing post-petition unless the debtor has officially rejected the contract. Rejection means that the debtor has decided to stop performing and the bankruptcy court has approved that decision. Alternatively, if the debtor has decided to continue to perform (assume) the contract, and the bankruptcy court has approved this assumption decision, the debtor will have to cure, in cash, any pre-petition amounts owed.
  • Until the debtor has made a decision about your contract, the debtor may be willing to make current post-petition payments under the contract. You should consider confirming this understanding with the debtor or its counsel in writing to protect your rights.
  • If you’re concerned that you won’t be paid for your post-petition performance or if you don’t want to continue to perform for other reasons, you may need an attorney to file a motion to compel the debtor or trustee to assume or reject the contract, or to seek “adequate protection” payments pending that decision. Bankruptcy courts often give a Chapter 11 debtor a long time to make this decision, even until a plan of reorganization is confirmed.  However, the court may be willing to order that you be paid currently for post-petition amounts and/or clarify that you have an administrative priority claim for your post-petition performance.

Is the debtor creditworthy? While these legal issues are important, it’s equally critical to assess the debtor’s financial condition after bankruptcy.  A bankruptcy filing relieves a debtor from the obligation to pay pre-petition unsecured creditor claims, and this can make a substantial difference to a debtor’s cash flow. Still, the debtor has to have sufficient liquidity to pay its post-petition administrative claims.

  • Many debtors obtain post-petition financing from lenders — known as debtor in possession or DIP financing — and this can provide the necessary liquidity to pay administrative claims. DIP financings are usually secured by a blanket security interest on all of the debtor’s assets, however, putting the DIP lender ahead of even administrative claims in the event of default.  
  • While not common, debtors do sometimes default under DIP financings. When that happens, the DIP lender will often foreclose on the debtor’s assets and the bankruptcy case will be converted to Chapter 7 liquidation. If so, not only will the DIP lender’s debt be paid first from the estate’s assets, but the administrative claims generated during the Chapter 11 case will become second in line to Chapter 7 administrative claims, such as the Chapter 7 trustee’s fees and expenses and those of his or her counsel. 
  • For these reasons, it’s still very important to be comfortable with a Chapter 11 debtor’s financial condition and its wherewithal to pay for post-petition sales before extending post-petition credit. Most debtors are required to file post-petition monthly financial reports (here’s an example from Delphi’s bankruptcy case), and they can serve as one source of financial information.

Consult with bankruptcy counsel. These general rules govern most scenarios, but dealing with a debtor post-petition can be complicated and raise many issues unique to your situation. For this reason, it’s best to get an attorney’s advice before engaging in any significant transactions with a debtor.

Business Bankruptcy Issues

Commercial Real Estate Leases: How Are They Treated In Bankruptcy?

Much like executory contracts, commercial real estate leases are governed by special rules in bankruptcy. If a lease’s term has not yet expired, it is known as an “unexpired lease” (yet more clever bankruptcy terminology). This post explores how landlords and tenants are treated in bankruptcy, first in the more common situation of a tenant’s bankruptcy and then briefly in the context of a landlord’s bankruptcy.

Assumption and rejection. If the debtor is the tenant under an unexpired commercial lease, it must either assume or reject the lease within 120 days of the filing of bankruptcy. The court can extend this time period without the landlord’s consent for 90 additional days, making a total of 210 days, but any further extensions require the landlord’s prior written consent. If the lease is not assumed (or assumed and assigned) within this period, the lease automatically will be deemed rejected and the debtor will have to move out. 

  • Assumption of a lease requires the debtor to reaffirm the lease, cure all pre- and post-filing defaults, and show that it will be able to perform its obligations in the future. Additional restrictions must be met before a lease located in a shopping center can be assumed or assigned. 
  • Rejection of a lease means that the lease is breached, the debtor tenant has to vacate the property, and the landlord can file a claim against the debtor’s estate for the amount of any past or future rent. 

Capping a landlord’s claim. If a lease is rejected, the landlord’s damage claim for termination of the lease will be treated as a pre-filing unsecured claim.  In addition, the claim for future rent under the lease will be capped at an amount equal to the greater of one year’s rent or fifteen percent of the remaining lease term, up to a maximum of three years’ worth of rent, calculated from the earlier of the date the bankruptcy petition was filed or the date when the landlord recovered possession of, or the tenant surrendered, the premises. This ability to cap a landlord’s claim in bankruptcy is often a major benefit to a debtor tenant, especially when the lease rejected is a long-term lease with rent obligations higher than current market rates. Landlords with security deposits, either in the form of cash or letters of credit, generally will be able to retain or draw on that security at least up to the amount of their capped bankruptcy claim.

Assignments of leases in bankruptcy. Although some leases contain restrictions or outright prohibitions on the tenant’s ability to assign the lease, many of these provisions will be unenforceable in bankruptcy. This can allow a debtor to “assume and assign” a lease to a third party over the landlord’s objection. Since third parties will often pay substantial sums to take over a lease with rent obligations below current market rates, these below-market leases can be valuable assets for debtors.   

The recent bankruptcy law changes. The 210 day maximum lease decision period represents one of the major changes enacted with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), discussed in an earlier post. Before these amendments took effect in October 2005, although debtors initially had only 60 days to assume or reject leases, they were permitted to seek extensions of this period without any statutory limitation. Cumulative extensions of a year or more, over a landlord’s objection, were not uncommon under the pre-BAPCPA version of the Bankruptcy Code. That is no longer possible under BAPCPA.

Impact on retailers. This change is particularly significant for retailers with dozens or even hundreds of leased stores. In the past, retailers usually evaluated sales at stores for at least one holiday shopping season, and sometimes two, before deciding whether to retain the store. Now a retailer has only seven months to make that decision. This shortened period also impacts a retailer’s ability to sell off its unwanted leases, especially through a sale of "designation rights" (the right to designate the assignee of a lease), as the buyer of those rights now will have a limited time to find buyers for those leases.

Landlord as debtor. Sometimes the debtor is not a tenant but a landlord. In that situation, although the debtor can reject a lease and no longer perform any of its duties as landlord, it cannot use bankruptcy to evict a tenant that prefers to stay in possession of the premises. In Section 365(h)(1) of the Bankruptcy Code, a special provision reminiscent of the rights of a licensee of intellectual property under Section 365(n), a tenant may elect to remain in the premises for the remaining term of the lease, plus any renewal or extension of the term that may be provided in the lease if enforceable under applicable state law. If it so elects, the tenant must continue to pay the rent required under the lease but can offset against that rent any damages caused by the landlord’s nonperformance. 

Sublandlord as debtor. When the debtor is a sublandlord (also known as a sublessor), these protections generally do not apply and the subtenant is at risk of losing possession of the premises.  Because a sublandlord is a tenant under a master lease (with the "real" landlord), if the debtor rejects the master lease it, and its subtenants, usually will not have any continuing rights to possession of the premises. Subtenants looking to protect themselves in such a situation often obtain, as part of their sublease, a non-disturbance agreement, direct lease right, or similar protection from the master landlord.

Get good advice. Whether the debtor is a tenant or a landlord (or both), bankruptcy can have a significant impact on commercial real estate leases and subleases. For this reason, it is important to get prompt legal advice on your particular lease, both at the time the lease is negotiated and in the event of bankruptcy, to protect your rights.

Recent Developments The Financially Troubled Company

New Delaware Decision Limits Direct Creditor Claims Against Directors In The “Zone Of Insolvency”

The Delaware Court of Chancery has issued another decision involving creditor claims against directors of a financially troubled corporation. In North American Catholic Educational Programming, Inc. v. Gheewalla, et al., 2006 WL 2588971 (Del. Ch. Sept. 1, 2006), Vice Chancellor Noble made two important holdings:

  • First, although derivative claims can be brought, creditors may not assert direct claims against directors of a Delaware corporation for alleged breaches of fiduciary duty that occur while the corporation is in the "zone of insolvency." 
  • Second, assuming Delaware law would allow any creditor to bring a direct, non-derivative claim against directors of an actually insolvent corporation (still an unresolved question), the suing creditor’s right to payment would have to be "clearly and immediately due." Thus, creditors with disputed or contingent claims likely will not be able to assert a direct claim for breach of fiduciary duty, even if the corporation is in fact insolvent.

A copy of the decision is available here. Thanks to the Delaware Business Litigation Report blog for reporting on it first. 

No direct claim in the "zone of insolvency." The court’s refusal to permit a creditor to assert a direct claim — as opposed to a derivative claim — against corporate directors for breach of fiduciary duty in the zone or vicinity of insolvency was based on its careful analysis of the arguments for and against such claims. The court summed up its reasoning:

Indeed, it would appear that creditors’ existing protections—among which are the protections afforded by their negotiated agreements, their security instruments, the implied covenant of good faith and fair dealing, fraudulent conveyance law, and bankruptcy law—render the imposition of an additional, unique layer of protection through direct claims for breach of fiduciary duty unnecessary. Moreover, any benefit to be derived by the recognition of such additional direct claims appears minimal, at best, and significantly outweighed by the costs to economic efficiency. One might argue that an otherwise solvent corporation operating in the ‘zone of insolvency’ is one in most need of effective and proactive leadership—as well as the ability to negotiate in good faith with its creditors—goals which would likely be significantly undermined by the prospect of individual liability arising from the pursuit of direct claims by creditors.

Unclear if direct claims can be brought at all, even in a case of actual insolvency. The court engaged in a different analysis, focused more on the deficiency of the actual allegations in the complaint, in dismissing direct claims against the directors during the corporation’s alleged actual insolvency. However, the court commented that, to the extent Delaware law would permit a creditor to have a direct claim against directors of an insolvent corporation for breach of fiduciary duty, the claim would have to involve invidious conduct directed at that creditor. In so holding, the court relied heavily on two earlier decisions of the Court of Chancery, one by Vice Chancellor Strine in Production Resources Group v. NCT Group, Inc., 863 A.2d 772 (Del. Ch. 2004) (discussed in an earlier post) and the other by Vice Chancellor Lamb in Big Lot Stores, Inc. v. Bain Capital Fund VII LLC, et al., 2006 WL 846121 (Del. Ch. March 28, 2006) (available here). These decisions, taken together, suggest that most if not all creditor claims for breach of fiduciary duty against directors of insolvent Delaware corporations will be characterized as derivative and not direct claims.

Developing trend against expanding a director’s exposure to creditor claims. The Production Resources, Big Lot Stores, and now North American Catholic Educational Programming decisions, together with the recent Trenwick America Litigation Trust case refusing to recognize a cause of action for deepening insolvency (discussed in an earlier post), reflect the Delaware Court of Chancery’s resistance to attempts by creditors to expand the liability of directors when a corporation is insolvent or in the zone of insolvency. Although well-stated derivative claims by creditors for breach of fiduciary duty may be recognized by the courts in some cases, a direct claim by a creditor — if such a claim exists at all under Delaware law — seems to be limited to the rare circumstance in which that particular creditor was the only creditor harmed by an alleged breach of fiduciary duty. The Delaware Supreme Court has yet to weigh in, but these four decisions from three different Vice Chancellors indicate that the Court of Chancery is developing a consistent view on these issues.

Business Bankruptcy Issues

Objections To Bankruptcy Claims: Ignore Them At Your Peril

If you’re a creditor in a bankruptcy case and diligently file a proof of claim on time, often months or even years may go by before you hear anything further about your claim from the debtor, bankruptcy trustee, or any other party. In fact, the only thing you may hear about your claim for a long time is an offer to purchase it made by one or more claims buyers. 

No news is not always good news. Unfortunately, the passage of time may lead you to believe that no objection to your claim will ever be filed. However, the urgency of reorganizing a debtor’s business or liquidating its assets means that the claims 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. As a result, an objection to your claim may be brought long after you filed it. When filed, the objection may assert that your claim amount doesn’t square with the debtor’s books and records or it may be based on any number of other grounds specific to the nature of your claim. 

Is that an objection to my claim? When an objection is filed, it may not always be obvious at first. While an objection may clearly identify that it is directed to your claim, in large cases the debtor or other estate representative has so many claims to address that the objection to your claim will most likely be combined with others. Instead of a pleading specifically mentioning your name in its title or text, the objection may have a name such as “Notice of Debtors’ Fourteenth Omnibus Objections To Claims (Substantive)” 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 a few lines, often in a list or chart, identifying that your claim is one of dozens to which an objection has been filed. 
  • Whatever the objection’s name or format, the point is the same: ignore it at your peril.  If you don’t respond to the objection timely your claim will likely be disallowed and you will recover absolutely nothing from the bankruptcy estate.

Diligence is critical. As in other legal contexts, protecting your rights in a bankruptcy case requires diligence. This can be a significant task. In major bankruptcy cases, literally thousands of pleadings can be filed during the course of a case. Many of these will be served on creditors and other parties, whether in paper or electronic form, yet only a few may be important to you or your claim. For this reason, it is critical that you or your attorney keep track of the pleadings filed in a bankruptcy case. As mentioned in an earlier post, there are often special websites designed to assist creditors in following large bankruptcy cases, in addition to the Court’s own electronic filing system. 

Protect your rights.  The bottom line is, if you see anything that looks like a claim objection, you should review all of the pages carefully, including its exhibits. If an objection to your claim is filed, a timely response will be required to protect your rights. Otherwise, you may find yourself with a disallowed and worthless claim.

Business Bankruptcy Issues

Trademark Licensor In Bankruptcy: Special Risk For Licensees

In an earlier post I discussed how a recent district court case gave trademark owners a leg up when a licensee files for bankruptcy. This begs the question: Does the advantage switch back to the licensee if the trademark owner files for bankruptcy? The answer generally, and perhaps surprisingly, is no. 

Limited protection of Section 365(n). Of course, it can be devastating for a licensee to lose access to licensed intellectual property. Often a licensee will build in licensed technology into its products or develop an entire business line or brand around a licensed trademark.  Recognizing how important in-licensed IP can be, in 1988 Congress added Section 365(n) of the Bankruptcy Code, giving licensees of certain types of intellectual property special protections in bankruptcy. These protections allow licensees to retain their rights to the licensed intellectual property – but there’s a catch. The Bankruptcy Code’s definition of “intellectual property” includes, among other things, patents, patent applications, copyrights, and trade secrets, but unfortunately for trademark licensees, it does not include trademarks.

Trademark licensee’s special risk. With no special protection, the trademark licensee faces the risk of having its license, a form of executory contract, rejected by the trademark owner in bankruptcy. If the trademark owner decides that the license is now unfavorable and a better deal can be had under a new license agreement with someone else, the trademark owner likely will reject the existing trademark license agreement and terminate the licensee’s rights to use the mark. The enforceability of phase-out provisions, which allow a licensee to continue to use a mark for a limited time period after a license is terminated, is unclear. Regardless, the trademark licensee eventually will lose its rights to the trademark following rejection. In some cases the ability to re-license can be of great value to a trademark owner in bankruptcy, and thus to its creditors, but it puts the licensee at substantial risk.

The bundled license. What about a license covering both trademarks and other intellectual property that is protected by Section 365(n)? Often a license of software or other products that involve copyrights or patents will include a license to use an associated trademark. In that case, even if the license were rejected, the licensee would have Section 365(n) rights to retain the "bankruptcy intellectual property" — in this example the rights to the copyrighted or patented IP — but would still lose the trademark license.  One case so holding is In re Centura Software Corp., 281 B.R. 660 (Bankr. N.D. Cal. 2002).  You can read that interesting decision here.

How can trademark licensees protect themselves? There are a few, albeit limited, strategies available for trademark licensees to protect themselves. Whether you are a trademark licensee or licensor, be sure to get advice from a bankruptcy attorney on your specific situation.

  • Unbundle the payments. In negotiating bundled licenses, the licensee should anticipate the prospect of losing rights to the trademark if a bankruptcy is filed. One approach would be to separate out any royalty or license payments for the trademark from those related to the other intellectual property being licensed. This way, the licensee can avoid having to pay amounts allocable to the rejected trademark license in order to retain its other IP license rights under Section 365(n). 
  • Take ownership of the mark. Would-be licensees with enough leverage sometimes demand that the trademark and its goodwill be transferred to them, coupled with a license back to the now-former trademark owner. This is perhaps the most effective method, but also the least likely to be achieved.
  • Get a security interest. Another strategy involves taking a security interest in the mark or the licensor’s other assets to secure the damage claim that the licensee would have if the trademark owner rejects the license. Licensees pressing for a security interest do so in part hoping that a debtor licensor faced with a secured claim for rejection damages may decide against rejecting the license in the first place.
  • Oppose a rejection motion. Once a bankruptcy is filed, a trademark licensee should engage counsel right away and consider challenging a debtor or trustee’s decision to reject the trademark license. If little good would come of the rejection for the debtor or its creditors, the licensee could oppose the motion arguing that the decision to reject is an inappropriate exercise of the debtor’s business judgment. Although such objections are rarely sustained, if successful this strategy could allow the licensee to continue to use the trademark without facing the consequences of a rejected license.

Short of these approaches, there is precious little trademark licensees can do to protect themselves from this bankruptcy risk. It is a fact that gives debtor licensors clear advantages and sometimes keeps trademark licensees up at night.

Recent Developments

Inside The Fed’s Thinking About Economic Conditions And Trends

Earlier today the Federal Reserve Board released minutes from the Federal Open Market Committee’s ("FOMC") most recent meeting, held on August 8, 2006.  Having made some recent posts about the number of corporate defaults and bankruptcies predicted for 2007 (see earlier posts here and here), I thought you might be interested to see what the FOMC’s minutes had to say about current economic conditions and indicators about the economy’s future direction.

Here are a few key excerpts:

In their discussion of the economic situation and outlook, meeting participants noted that the slowing of GDP growth in the second quarter was generally in line with expectations, reflecting the continued cooling of the housing market, the restraining influence on demand of higher energy prices, and the lagged effects of past increases in interest rates. Going forward, output was expected to advance at a pace at or slightly below the economy’s potential rate of growth, but several participants noted that the annual revision to the national income and product accounts suggested this growth rate likely was lower than previously believed. Incoming information with regard to inflation had not been encouraging. Still, most participants thought that, with energy prices possibly leveling out, aggregate demand moderating, and long-term inflation expectations contained, core PCE inflation likely would decline gradually from its recent elevated level, though the upside risks to inflation were significant.

In their discussion of the major sectors of the economy, participants noted that residential construction activity had continued to recede over the past few months and cited the housing sector as a downside risk to the outlook for growth. The rate of new home sale cancellations, which was identified as an important leading indicator by some contacts in the construction industry, had spiked higher. Single-family housing starts and permits continued to fall, and inventories of unsold housing appeared to have risen significantly, pointing to continued slowing in this sector. Some participants observed that the slowing seemed to be orderly thus far, but it was also noted that in some areas of the country housing construction had experienced a relatively sharp fall. In general, participants expressed considerable uncertainty regarding prospects for the housing sector.

Meeting participants noted that the continued increases in energy prices and borrowing costs appeared to have restrained consumer spending growth in recent months. Contacts in the retail sector generally reported a continued slowing of growth in sales, although the situation differed somewhat by region and type of good or service. Reliable, comprehensive data were not yet available on recent house price movements, but the rate of appreciation appeared to be moderating and was likely to slow further in coming months. The slower pace of increase in housing wealth would restrain consumption growth, though by how much was uncertain. However, the financial condition of households, as judged by indicators such as bankruptcy filings and loan delinquencies, appeared to remain solid. Overall, consumption spending seemed likely to expand at a moderate pace in coming quarters.

Although business fixed investment in the second quarter was a little lower than had been expected, participants noted that this development appeared mainly to reflect the timing of purchases, particularly of transportation equipment, and not weakness in the underlying trend. Some participants noted that nonresidential construction had continued to strengthen, offsetting some of the contraction in residential construction. Looking forward, strong business balance sheets and high profitability were seen as supporting continued growth in expenditures on software and equipment. However, it was noted that if the reported slowing of increases in retail sales continued, businesses might trim capital spending plans.

In short, it’s unclear whether we’ll see the "soft landing" slowdown in growth that the FOMC expects, or a more significant housing-led downturn as some, such as Professor Nouriel Roubini of the NYU Stern School of Business, are predicting.  Either way, these minutes discuss some of the key factors that are likely to influence the economy — and the Fed — in the coming months. 

For those interested in reading the entire FOMC minutes (including the statement that many participants in the FOMC meeting viewed the August pause in raising interest rates as a "close call"), you can find them here.