Business Bankruptcy Issues

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Business Bankruptcy Issues Recent Developments

Delaware Bankruptcy Court Adopts New Local Rule For Section 363 Sales

The Delaware Bankruptcy Court has recently adopted amended Local Rules, which became effective on February 1, 2008, and they include meaningful changes to the procedures governing Section 363 sales of assets. New Local Rule 6004-1, entitled "Sale and Sale Procedures Motions," requires additional disclosure and the highlighting of certain key provisions often seen in sale motions.

By following the links in this sentence you can find the redline version and clean version of the new Delaware Bankruptcy Court Local Rules.

The Section 363 Sale. As a reminder, a bankruptcy asset sale often happens 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. The sale is generally 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. The debtor must seek bankruptcy court approval of a sale that is not in the ordinary course of business and of any effort to transfer executory contracts, intellectual property licenses, or commercial real estate leases to the buyer.

Sale Motion Requirements. The new local rule first addresses motions to sell property of the estate. A copy of the proposed or near-final purchase agreement must be attached to the motion, as well as a proposed sale order, and any request for a consumer privacy ombudsman under Section 332 of the Bankruptcy Code must be included. The most interesting changes, however, are in the list of provisions which, if included in the motion or sale order, must be highlighted together with a justification for each such provision. These include the following:

  • Sale to insiders
  • Agreements with management
  • Releases
  • Private sale or no competitive bidding
  • Closing and other deadlines
  • Good faith deposit
  • Interim agreements with proposed buyer
  • Use of sale proceeds
  • Section 1146 tax exemption
  • Retention of records
  • Sale of avoidance actions
  • Successor liability findings requested
  • Sale free and clear of leases or licenses
  • Credit bid
  • Waiver of 10-day stay under Rule 6004(h)

A Few Specifics. To get a sense of the changes made, here’s what the amended rule now requires for disclosure of agreements with management included as part of a sale motion:

Agreements with Management. If a proposed buyer has discussed or entered into any agreements with management or key employees regarding compensation or future employment, the Sale Motion must disclose (a) the material terms of any such agreements, and (b) what measures have been taken to ensure the fairness of the sale and the proposed transaction in the light of any such agreements.

Similarly, if a finding is requested regarding a tax exemption under Section 1146(a) of the Bankruptcy Code, the motion must now detail the following:

Tax Exemption. The Sale Motion must highlight any provision seeking to have the sale declared exempt from taxes under section 1146(a) of the Bankruptcy Code, the type of tax (e.g., recording tax, stamp tax, use tax, capital gains tax) for which the exemption is sought. It is not sufficient to refer simply to "transfer" taxes and the state or states in which the affected property is located.

Another part of the new rule requires more disclosure of efforts to sell free and clear of leases and licenses:

Sale Free and Clear of Unexpired Leases. The Sale Motion must highlight any provision by which the debtor seeks to sell property free and clear of a possessory leasehold interest, license or other right.

Sale Procedures Motions. In addition to an actual sale motion, the new local rule includes new provisions addressing motions for approval of sale and auction procedures. Although these provisions are already typically set forth in motions, the rule makes mandatory the highlighting of certain ones, including the following:

  • Financial qualification procedures
  • Deadlines for submitting bids
  • Format of overbids
  • Good faith deposit
  • No-shop or no-solicitation rules
  • Break-up/topping fee and expense reimbursement
  • Bidding increments and use of break-up fees
  • Details of auction procedures

Other Important Local Rule Changes. In addition to a number of minor changes, the amended Local Rules include three significant additions governing (1) discovery motions, (2) service of discovery materials, and perhaps most importantly, (3) electronic or e-discovery. These new rules are found at Local Rules 7026-1, 7026-2, and 7026-3, respectively. Local Rule 3007-1 on omnibus claim objections, discussed in a prior post, has been revised to reflect Delaware’s continued adherence to its local practice notwithstanding the recent national rule changes. (Click on the links in this sentence for more on the national rule amendments and Delaware’s decision to retain its own omnibus claim objection procedures.) Also of note, amended Local Rule 9010-1 now makes explicit the requirement that associated Delaware counsel file all papers and attend proceedings before the Court.

Conclusion. While many of the amended sale motion rules are not new to Delaware practice, Local Rule 6004-1 will change the way sale and sale procedures motions are prepared going forward. Chapter 11 debtors must comply with the new rule and that should give creditors and potential overbidders an easier time spotting the material provisions in these motions.

Business Bankruptcy Issues The Financially Troubled Company

Licensing Intellectual Property From An Israeli Company: What Happens If There’s A Bankruptcy?

Many technology companies are based in Israel and license intellectual property to companies in the United States and around the world. This raises an interesting question: what happens if the Israeli company, as licensor, goes into bankruptcy or liquidation in Israel? The latest edition of Cross Border Commentary, a publication by the International Business Practice of my firm, Cooley Godward Kronish LLP, has just addressed that very question.

The U.S. Law Answer.  Before turning to Israeli law, let’s look at how this issue plays out under the United States Bankruptcy Code. A licensor in bankruptcy or its bankruptcy trustee has the option of assuming (keeping) or rejecting (breaching) a license. Generally, a debtor licensor can assume a license if it meets the same tests (cures defaults and provides adequate assurance of future performance) required to assume other executory contracts.  Many licensees will not have a problem with assumption of their license as long as the debtor can actually continue to perform. Instead, the real concern for licensees is the fear of losing their rights to the licensed IP, which often can be mission critical technology, if the license is rejected.

  • Special protections. Recognizing this concern, the United States Bankruptcy Code, in Section 365(n), provides licensees with special protections.  If the debtor or trustee rejects a license, under Section 365(n) a licensee can elect to retain its rights to the licensed intellectual property, including even a right to enforce an exclusivity provision. In return, the licensee must continue to make any required royalty payments. The licensee also can retain rights under any agreement supplementary to the license, which includes source code or other forms of technology escrow agreements.  Taken together, these provisions protect a licensee from being stripped of its rights to continue to use the licensed intellectual property.
  • Watch out for trademarks. While many people would expect intellectual property to include trademarks, the Bankruptcy Code has its own limited definition of "intellectual property." The bankruptcy definition includes trade secrets, patents and patent applications, copyrights, and mask works.  Importantly, however, it does not include trademarks. This distinction means that trademark licensees enjoy none of Section 365(n)’s special protections and those licensees are at risk of losing their trademark rights in a bankruptcy. 

For more on these subjects, you may find these earlier posts, "Intellectual Property Licenses: What Happens In Bankruptcy?" and "Trademark Licensor In Bankruptcy: Special Risk For Licensees" of interest.

The Israeli Perspective. An article in Cooley’s Cross Border Commentary, prepared by Einat Meisel of the Israeli law firm of Gross, Kleinhendler, Hodak, Berkman and Co., discusses a Tel-Aviv District Court decision involving these issues. When an Israeli company known as Commodio Ltd. entered liquidation, two of its intellectual property licensees sought to retain rights under their license agreements with Commodio. In ruling on the effort, the Israeli court made several important holdings:

  • The licensees could continue to use the IP as long as they made required any royalty payments and complied with the terms of use in the agreements, with payments to be made to the liquidator.
  • The licensees could gain access to the underlying source code behind the object code covered by their licenses provided this did not impose substantial expense on the company in liquidation.
  • No transfer of ownership in the IP could occur due to the liquidation, as this would be contrary to Israeli bankruptcy law.
  • A right of first refusal covering certain of the intellectual property would be enforceable in the bankruptcy.

Comparison To A U.S. Bankruptcy. With a few key differences, the outcome in the Commodio case is similar to the treatment under U.S. law. Under Section 365(n)’s provisions, licensees would have the ability to retain their rights to the IP, with any royalty payments being made to the bankruptcy estate. If an agreement contained a source code license, the licensees could also access the source code under Section 365(n). However, absent a license grant to the source code, the outcome would likely be different in a U.S. bankruptcy.  Provisions purporting to transfer ownership of the IP upon a bankruptcy or liquidation would not be enforceable in a U.S. bankruptcy. Finally, the right of first refusal enforced in the Israeli case might not be enforced in a U.S. bankruptcy if the agreement were rejected but could if the license were assumed. 

Get Advice. Licensing intellectual property from a foreign corporation raises a number of issues, including what happens if the foreign licensor goes bankrupt or becomes insolvent. Potential licensees should be sure to get expert advice on the applicable foreign law, including the implications of bankruptcy, when licensing IP from a foreign company. Although licensees from Israeli companies can find some comfort in the Commodio decision, it remains important to get advice on Israeli law specific to your situation. 

Business Bankruptcy Issues Recent Developments

Two Ways To Get The Updated Bankruptcy Code Online For Free

Looking for a free, online and updated version of the entire Bankruptcy Code, reflecting the amendments made by the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA")? Now there are two ways to access it.

These are handy resources for attorneys and others who need to find the up-to-date Bankruptcy Code online.

Business Bankruptcy Issues Recent Developments

First Appellate Court Decision Addresses Question Left Open In The Supreme Court’s Travelers Opinion: Can Unsecured Creditors Recover Post-Petition Attorney’s Fees?

Happy New Year to everyone. I’m back from a holiday blogging break with a report on the first appellate decision to address the question left open in last year’s U.S. Supreme Court decision in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. — whether post-petition attorney’s fees can be added to unsecured claims. Although unrelated, this new decision also tackles the interesting question of whether a guarantor of a debt can become liable if the payment of the debt by the primary obligor later is returned in a preference settlement.

The Travelers Case. As a brief refresher, the U.S. Supreme Court overruled the Ninth Circuit’s so-called Fobian rule in the Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. decision (available here) in March 2007. However, it did not decide whether unsecured creditors could recover, as part of their unsecured claims, post-petition attorney’s fees incurred during the course of the bankruptcy case. For more on the Travelers decision, you may find this earlier post of interest.

A Developing Split. Since the Travelers decision, two bankruptcy courts issued decisions on the open issue, coming to different conclusions. 

  • In May 2007, in the In re Qmect, Inc. decision (available here), the U.S. Bankruptcy Court for the Northern District of California held that unsecured creditors could recover post-petition attorney’s fees. For more on that decision, see this earlier post on the case and its analysis. 
  • In July 2007, in the In re Electric Machinery Enterprises, Inc. case (available here), the U.S. Bankruptcy Court for the Middle District of Florida came to the opposite conclusion, following a majority of courts that had addressed this issue unrestrained by the Ninth Circuit’s Fobian decision. See this previous post for more on the Florida decision.
  • Commentators, including with the recent article written by the American Bankruptcy Institute‘s Scholar in Residence Professor Mark Scarberry, have joined the fray as well.

The SNTL Corp. Ruling. On December 19, 2007, the Ninth Circuit Bankruptcy Appellate Panel ("BAP") issued its decision in the In re SNTL Corp. case (available here). After carefully reviewing both the Qmect and Electric Machinery decisions, as well as pre-Travelers case law, the BAP chose to follow Qmect, holding that "claims for postpetition attorneys’ fees cannot be disallowed simply because the claim of the creditor is unsecured." Judge Dennis Montali, writing for the unanimous BAP panel, first explained its analysis of the interplay between Sections 502 and 506(b):

We are not persuaded by the approach of the Electric Machinery court and, like Qmect, we reject the argument that section 506(b) preempts postpetition attorneys’ fees for all except oversecured creditors. While we cannot predict how the Ninth Circuit will decide this issue in Travelers, we do find a clue in Joseph F. Sanson Inv. Co. v. 268 Ltd. (In re 268 Ltd.), 789 F.2d 674, 678 (9th Cir. 1986), where the Ninth Circuit observed that section 506(b) defines secured claims and does not limit unsecured claims:

When read literally, subsection (b) arguably limits the fees available to the oversecured creditor. When read in conjunction with § 506(a), however, it may be understood to define the portion of the fees which shall be afforded secured status. We adopt the latter reading.

268 Ltd., 789 F.2d at 678.

Next, the BAP discussed Section 502(b)(1)’s requirement that the court determine the amount of an unsecured claim as of the petition date: 

The Electric Machinery court, like the bankruptcy court here and many of the pre-Travelers majority courts, disallowed the postpetition fees of an unsecured creditor because section 502(b)(1) provides that a bankruptcy court  “shall determine the amount of such claim . . . as of the date of the filing of the petition” and the postpetition fees did not exist as of that date. Elec. Mach., 371 B.R. at 551; Pride Cos., 285 B.R. at 373. Because the amount of fees incurred postpetition cannot be determined or calculated as of the petition date, section 502(b) purportedly precludes their allowance. Id. We disagree with this approach, as it is inconsistent with the Bankruptcy Code’s broad definition of “claim,” which — as discussed previously — includes any right to payment, whether or not that right is contingent and unliquidated. See 11 U.S.C. § 101(5)(A); Qmect, 368 B.R. at 884.

The BAP then held that the Supreme Court’s 1988 Timbers decision did not apply:

We believe that Electric Machinery’s reliance on Timbers is misplaced. Timbers provided that an undersecured creditor could not receive postpetition interest on the unsecured portion of its debt. Timbers, 484 U.S. at 380. This holding is consistent with section 502(b)(2), which specifically disallows claims for unmatured interest. Inasmuch  as section 502(b) does not contain a similar prohibition against attorneys’ fees, the comparison between the current issue and that presented in Timbers is not persuasive.

Finally, the BAP held that it was unnecessary to reconcile the competing public policy considerations advanced by the Electric Machinery and Qmect decisions:

Because we find that the Bankruptcy Code itself provides the answer to this issue (by not specifically disallowing postpetition fees), we do not attempt to reconcile these policy concerns. In the end, it is the province of Congress to correct statutory dysfunctions and to resolve difficult policy questions embedded in the statute.

A Ninth Circuit Decision To Come? In the first quote above, you may have picked up the BAP’s reference to the Ninth Circuit having this issue before it in the Travelers case. That case, on remand from the Supreme Court, appears to have been fully briefed. Any decision from the Ninth Circuit itself on the issue would, of course, supersede this BAP decision and be controlling authority in the circuit, but it may be months before such a ruling comes down.

A Bonus Issue: Guarantor’s Liability Revived After A Preference Settlement. The facts of the SNTL Corp. case are complex, but the key facts are fairly straightforward. In short, one of the debtor’s insurance company subsidiaries owed money to the creditor and the debtor guaranteed the debt. Although the subsidiary paid the creditor, the subsidiary was later placed into state insolvency proceedings. The state insurance commissioner sued the creditor for return of the payment on preference grounds. The creditor settled the preference case and returned most of the payment ($110 million of a $163.4 million original payment). The creditor thereafter amended its proof of claim in the debtor’s Chapter 11 case, seeking recovery under the guaranty of the returned preference.

  • After first determining that the guaranty’s language permitted the creditor to assert a claim to the extent provided by law, the BAP next held, "[w]hile we located no Ninth Circuit or California case precisely on point, we agree that the return of a preferential payment by a creditor generally revives the liability of a guarantor."
  • The BAP cited to various case and restatement authority for the proposition that although a guarantor is discharged on payment of a debt, a preferential payment is deemed to be no payment at all.
  • The BAP also held that repayment of a preference in a settlement, following a preference lawsuit, is not a voluntary payment that would avoid the guarantor’s liability.
  • Given the risk of a preference recovery, the creditor’s revival claim under the guaranty was a contingent claim as of the petition date and became allowable once the contingency occurred following the petition. As a result, the creditor’s claim for the full $110 million of the preference settlement was an allowed claim.

An Important Decision. BAP decisions are not binding precedent in the Ninth Circuit, but this first appellate decision on the open, post-Travelers question may encourage unsecured creditors to include post-petition attorney’s fees as part of their allowed unsecured claims when their contracts or a statute provides for them outside of bankruptcy.  We may see creditors begin to include such amounts in unsecured claims at an increasing pace, while we wait for the Ninth Circuit’s decision on this issue in the remanded Travelers case. The added bonus of the SNTL Corp. court’s guaranty analysis and holding makes this decision an even more interesting, and important, read.

Business Bankruptcy Issues

Chapter 11 Plan Ballots: A New Resource Goes Online

The Altman Group, one of a number of companies that provides bankruptcy claims and balloting services, has just launched a new Bankruptcy Ballot Archive. The Archive makes available a range of different types of ballots, which are used for voting on Chapter 11 bankruptcy plans of reorganization. The ten ballot categories on the Archive include the following:

  • Asbestos/Mass Tort Cases
  • Bondholder Ballots
  • Contested Plan Solicitations
  • Convenience Class Election
  • Equity Holder Ballots
  • Pre-Packaged and Pre-Negotiated Plan Ballots
  • Ballots with Releases

For debtors and restructuring professionals looking for a broad spectrum of sample ballot forms to consider for a particular Chapter 11 plan, this new archive is a good place to start. 

Business Bankruptcy Issues Recent Developments

Delaware Bankruptcy Court Opts Out Of Newly Amended Rule 3007’s Procedures For Omnibus Claim Objections

As described in a post earlier this week, one of the major changes made by the new amendments to the Federal Rules of Bankruptcy Procedure that took effect on December 1, 2007 was the inclusion of limits on the use of omnibus claim objections. Newly revised Rule 3007 restricts omnibus objections to certain situations and imposes formatting standards on the motions that can be filed. 

When describing the amended rule, I commented that the Delaware Bankruptcy Court, through Local Rule 3007-1, has had its own omnibus objection procedures for some time and that they seemed to be in conflict with the new national rule. Well, taking advantage of the "unless otherwise ordered by the court" language in amended Rule 3007(c), Chief Judge Mary F. Walrath of the Delaware Bankruptcy Court issued this General Order noting the conflict but directing that the amended Rule 3007(c) "shall not be applicable to omnibus objections that are filed in accordance with Local Rule 3007-1." As a result, barring an individual judge choosing to apply the national Rule 3007 procedure in a particular situation, omnibus objections in Delaware cases will continue to be governed by Delaware’s own local procedures.

Special thanks to Chuck Kunz of MorrisJames, publishers of the Delaware Business Bankruptcy Report, for alerting me to Delaware’s new General Order.

Business Bankruptcy Issues Recent Developments

Don’t Miss The Important Business Bankruptcy Rule Amendments That Just Took Effect

On December 1st of almost every year, amendments to the Federal Rules of Bankruptcy Procedure — the ones that govern how bankruptcy cases are managed — take effect to address issues identified by an Advisory Committee made up of federal judges, bankruptcy attorneys, and others. Often the changes are relatively minor and of interest only to bankruptcy practitioners, but this year’s set has made some significant changes that will directly impact debtors, creditors and other stakeholders.

A Look At The Amendments. You may find it interesting to see the entire group of amendments together, so I have included two links. The first is to the full "clean" set of the amended rules. The second is to a redline showing the changes made by these amendments to the existing rules, together with the Advisory Committee’s comments.

The Omnibus Objection Problem. One of the most significant amendments will make changes to the popular practice of filing omnibus objections. In large cases the debtor or other estate representative has so many claims to address that they have combined objections to dozens — sometimes hundreds — of different claims in one single motion. The objection may have a name such as “Debtors’ Fourteenth Omnibus Objections To Claims (Substantive)” or some similarly titled document. Click here for one example. In a post last year called "Objections To Claims: Ignore Them At Your Peril," I discussed how it can be hard to tell which claims an omnibus objection is targeting.

  • The format has often meant that the only reference to an individual creditor is buried within the objection’s many pages of text and exhibits, typically in an attached list or chart.
  • If the creditor doesn’t respond to the objection timely, its claim will likely be disallowed and it will recover absolutely nothing from the bankruptcy estate.

The Amended Rule 3007: An "Anti-Gotcha" Solution. The new rules restrict the use of omnibus objections to certain limited circumstances and impose formatting standards. Otherwise, each claim will require its own separate claim objection unless the combined objection covers claims filed by the same person or entity. What grounds for objection can be made by an omnibus objection under the newly revised Rule 3007?

  • Duplicate claims;
  • Claims filed in the wrong case;
  • Original claims that were amended by later claims;
  • Claims that were not timely filed;
  • Claims that have already been paid or released;
  • Claims filed in a form that does not comply with applicable rules;
  • Claims that are really asserting an equity interest in the debtor; and
  • Priority claims that assert an amount in excess of the maximum amount in the Bankruptcy Code.

In short, if the claim is being challenged on substantive grounds, rather than more technical or procedural ones, then the objection will have to be filed one claimant at a time.

When an omnibus objection does make the permitted objections, it will now have to list claimants in alphabetical order, cross-reference claim numbers, give the ground for the objection and cross-reference that to the text of the objection, describe the objector and the reason for the objection in the document’s title, and combine no more than 100 claims in a single objection. This is all designed to make it easier for the creditor to figure out whether its claim is included and the basis for the objection.

Amended Rule 4001: The Clearer Disclosure Rules. Changes have been made to the rule that governs motions and stipulations for use of cash collateral and obtaining debtor in possession (DIP) financing. The amended rules now require that more details about the key provisions of cash collateral and DIP financing terms and conditions be stated in the motion, that proposed forms of order be filed with the motion, and that cross-references be made in the motion to where in the cash collateral or DIP financing agreements and proposed orders the key provisions are reflected. Since some financing agreements can run hundreds of pages long, with complex formulas and provisions, this rule change is designed to make it easier for the court and the parties to understand their material features without wading through the entire document.

New Rule 6003: Putting The Breaks On Some "First Day" Orders. Another major change is the addition of Rule 6003. This new rule provides that "except and to the extent that relief is necessary to avoid immediate and irreparable harm, the court shall not, within 20 days after the filing of the petition, grant relief" regarding three key areas:

  • The employment of professionals;
  • A motion to pay any prepetition claims (read: critical vendors) or to use, sell, lease (Section 363 sales), or incur an obligation for property of the estate, other than cash collateral or DIP financing motions; or
  • Assumption or assignment of any executory contract or unexpired lease (including commercial real estate leases).

As drafted, unless there is an emergency, and then only to the extent it’s really necessary, the bankruptcy court should defer these decisions until after the 20th day following the filing of the Chapter 11 bankruptcy petition (although technically these apply under the other chapters of bankruptcy). One reason for the rule is to give time for a creditors committee to be appointed and retain counsel before important decisions are made. That said, the exceptions for cash collateral and DIP financing, as well as for rejection of leases and other executory contracts, means a lot can still be done during the early part of a case. When Section 363 sale or critical vendor motions come up on an emergency basis, it’ll be interesting to see how often courts, in applying this new rule, find the existence of irreparable harm.

Amended Rule 6006: Assumption, Assignment, And Rejection Of Executory Contracts. Similar to Rule 3007, Rule 6006 has been changed to put limits on when omnibus motions can be used to deal with executory contracts and leases. Under new Rule 6006(e), absent special court authorization, omnibus motions may be used for multiple executory contracts or leases only when all of the executory contracts to be assumed or assigned are (1) between the same parties, or (2) being assigned to the same assignee. This latter provision likely covers most Section 363 asset sales, so non-debtor contracting parties should continue to carefully review those motions, as discussed in this earlier post. An omnibus motion may also be used when a debtor or trustee seeks to assume, but not assign to more than one assignee, real property leases. In addition, omnibus motions may be used to request rejection of multiple executory contracts or leases.

New Rule 6006(f) provides that, when allowed, these omnibus motions can list no more than 100 executory contracts or leases in any one motion (unlike the chart on this fairly typical pre-amendment motion), and multiple motions will need to be numbered consecutively. The new rule also requires that permitted omnibus motions provide a variety of new information, including:

  • An alphabetical listing by party name;
  • The terms of the assumption or assignment, including for curing defaults; and
  • The identity of the assignee and the adequate assurance of future performance to be provided.

A Few Other Changes. The other amendments this year (1) permit a court to consider a change of venue, (2) clarify when corporate ownership disclosure needs to be made, (3) address constitutional challenges to statutes, and (4) specify procedures for protecting social security numbers and other private information in court filings. Check the clean or redline sets linked above to read these additional rule amendments.

Conclusion. This year’s amendments to the Federal Rules of Bankruptcy Procedure have more than their share of real changes and they will have an impact on business bankruptcy cases. The omnibus motion changes should help creditors from missing when their claim is the target of an objection and contract parties from failing to see that their executory contract or lease is part of a motion to assume and assign. Although cash collateral and DIP financing motions are not affected, the new irreparable harm standard for certain relief in the first 20 days of a case may prove interesting when emergency Section 363 sales are attempted. Stay tuned.