Business Bankruptcy Issues

Showing: 99 - 105 of 163 Articles
Business Bankruptcy Issues Recent Developments

Northern District Of California Bankruptcy Court Proposes Amendments To Local Rules

As bankruptcy lawyers know, complying with local rules is an essential part of appearing before a particular court. In response to the changes made by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (known as BAPCPA), as well as the implementation of the electronic case filing system (called ECF), the Bankruptcy Judges for the Northern District of California have proposed a set of amendments to the Court’s local bankruptcy rules.

  • You can find a clean version and a redline version of the proposed amended local rules by clicking on the appropriate link in this sentence.
  • Attorneys or others wishing to comment on the local rules may do so by going to this website form or by sending those comments to the address indicated on that page. The deadline is September 27, 2007.

Among the amendments affecting Chapter 11 corporate bankruptcy cases are those governing  replacement of a "responsible individual" for a Chapter 11 debtor or debtor in possession, entry of a final decree closing a case, and the general electronic case filing procedures. A number of other revisions are aimed at consumer bankruptcy cases.

Although the changes do not appear to be dramatic, attorneys who practice before the Northern District of California, and businesses with cases or adversary proceedings pending in that court, will want to stay up to date on these local rule amendments.

Business Bankruptcy Issues Recent Developments

Lack Of Recognition: New Case Shows That Chapter 15 International Bankruptcy Protection Isn’t Automatic

On August 30, 2007, in twin decisions in recent cases involving two Bear Stearns hedge funds (available here and here), Judge Burton R. Lifland of the U.S. Bankruptcy Court for the Southern District of New York made clear that recognizing a foreign insolvency proceeding in a Chapter 15 cross-border bankruptcy case is not to be "rubber stamped by the courts."  The decision is of particular interest because Judge Lifland was one of the authors of Chapter 15 and the Model Law on Cross-Border Insolvency on which it is based.

The Bankruptcy Court’s Ruling. In a nutshell, the Bankruptcy Court held that although the two hedge funds were organized under the laws of the Cayman Islands, their business operations were in New York and not in the Cayman Islands. As such, the Bankruptcy Court would not recognize the Cayman Islands insolvency proceeding as either a "foreign main proceeding" or a "foreign nonmain proceeding." If you’re unfamiliar with this terminology, keep reading for an overview of Chapter 15 and more details on the decision.

A Chapter 15 Refresher. On October 17, 2005, as part of the Bankruptcy Abuse Prevention and Consumer Protection Act (known as BAPCPA), a new Chapter 15 of the Bankruptcy Code went into effect governing ancillary and other cross-border cases. (For those already familiar with ancillary proceedings, Section 304 of the Bankruptcy Code, which previously governed those proceedings, was repealed although many of its concepts were retained in Chapter 15.)

  • The main purpose of enacting Chapter 15 was to incorporate the Model Law on Cross-Border Insolvency as part of the Bankruptcy Code. 11 U.S.C. § 1501(a). My partner Adam Rogoff, who has significant experience with international insolvency matters, has prepared a very helpful chart comparing Chapter 15 and the Model Law’s provisions.
  • Chapter 15 is used principally by representatives of, or creditors in, foreign insolvency proceedings to obtain assistance in the United States, by a debtor or others seeking to obtain assistance in a foreign country regarding a bankruptcy case in the United States, or when both a foreign proceeding and a bankruptcy case in the United States are pending with respect to the same debtor. 11 U.S.C. § 1501(b). 

Several important terms involving the different types of foreign insolvency proceedings are key to understanding the scope of Chapter 15 and Judge Lifland’s ruling. 

  • A “foreign proceeding” means “a collective judicial or administrative proceeding in a foreign country, including an interim proceeding, under a law relating to insolvency or adjustment of debts in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court, for the purpose of reorganization or liquidation.” 11 U.S.C. § 101(23). 
  • For purposes of Chapter 15, “debtor” means “an entity that is the subject of a foreign proceeding.” 11 U.S.C. § 1502(1). 
  • A "foreign main proceeding" means a foreign proceeding pending in the country where the debtor has the center of its main interests which, in the absence of contrary evidence, is presumed to be the location of the debtor’s registered office. 11 U.S.C. §§ 1502(4) and 1516(c). 
  • A "foreign nonmain proceeding" means a foreign proceeding, other than a foreign main proceeding, pending in a country in which the debtor has an “establishment,” defined as a place of operations where the debtor carries out a nontransitory economic activity. 11 U.S.C. §§ 1502(2) and (4). 

Chapter 15’s basic procedure is straightforward. A case is commenced when a foreign representative, often a liquidator or provisional liquidator, files a petition for recognition of a foreign proceeding. 11 U.S.C. §§ 1504 and 1515(a). If properly filed, the bankruptcy court is entitled to presume that the facts stated in the petition are correct and the attached documents are authentic. 11 U.S.C. §§ 1516(a) and (b). As long as recognition would not be manifestly contrary to the public policy of the United States, the court must enter an order recognizing the foreign proceeding (here’s an example order). 11 U.S.C. §§ 1506 and 1517(a). 

Evidence Trumps Presumptions. With all this in mind, Judge Lifland held that the Cayman Islands proceeding could not be considered either a "foreign main" or a "foreign nonmain" proceeding. Despite Chapter 15’s presumption that the registered office or place of incorporation, here the Cayman Islands, would be a debtor’s "center of main interests" (known in the trade as the "COMI"), other evidence showed that the actual center of their activity was in New York. This, Judge Lifland held, precluded recognition of the Cayman Island proceeding as a foreign main proceeding. Also, without a true business presence there, the Bankruptcy Court could not conclude that the Cayman Islands was a place where the funds had "nontransitory economic activity," precluding foreign nonmain recognition. Judge Lifland held that even in the absence of objection, Chapter 15 places the burden of proof on these issues on the foreign representatives. Here, the facts in the petition and related papers showed that New York, and not the Cayman Islands, was the COMI for the funds.

Is Non-Recognition The End Of The Road? One of the most interesting aspects of Judge Lifland’s decision is the door he left open to the foreign representatives. Although the two hedge funds could not get protection under Chapter 15 of the Bankruptcy Code based on their filing in the Cayman Islands, they have the option of filing an involuntary Chapter 7 or Chapter 11 bankruptcy case in the United States.

  • Although Section 304 of the Bankruptcy Code, the old "ancillary proceedings" section, was repealed when Chapter 15 was enacted, Section 303 — and the ability of foreign representatives to file an involuntary Chapter 7 or Chapter 11 bankruptcy case — was not repealed.
  • Judge Lifland noted that Section 303(b)(4) of the Bankruptcy Code allows a foreign representative, such as the provisional liquidators appointed by the Cayman Islands court, to file an involuntary bankruptcy petition against the hedge funds and obtain bankruptcy protection in this manner.

Additional Reading In The Blogs. For more on the case, be sure to read Jordan Bublick’s informative post on his Miami Florida Bankruptcy Law blog and Chris Laughton’s commentary on his Insolvency Blog out of the UK. For the hedge fund industry’s perspective, you may find this post on the Hedgefunds Weblog of interest.

A Few Observations. With many offshore investment funds operating in the United States, Chapter 15 filings may become even more commonplace in the future, especially if we continue to encounter the kind of turbulence recently seen in the financial markets. Although the enactment of Chapter 15 made it easier for foreign representatives to get bankruptcy protection in the United States, the process is not automatic. As Judge Lifland’s decision shows, bankruptcy courts will scrutinize the facts — even in essentially unopposed cases — before agreeing to formally recognize a foreign proceeding. Without such recognition, foreign representatives will have to fall back on the more cumbersome involuntary bankruptcy process or find themselves with no U.S. bankruptcy protection at all.

Business Bankruptcy Issues Recent Developments The Financially Troubled Company

Delaware Supreme Court Issues Long-Awaited Decision In Deepening Insolvency Case

On August 14, 2007, the Delaware Supreme Court, sitting en Banc and following oral argument, issued its decision in the Trenwick America Litigation Trust v. Billet deepening insolvency case. Rather than write its own opinion, the Delaware Supreme Court released a two-page order affirming Vice Chancellor Strine’s August 10, 2006 Chancery Court decision "on the basis of and for the reasons assigned by" the Chancery Court in its opinion. A copy of the Chancery Court opinion is available here. 

The End Of Deepening Insolvency In Delaware. By adopting the basis and reasoning of the lower court’s opinion, the Delaware Supreme Court ratified Vice Chancellor Strine’s decision that there is no cause of action for deepening insolvency under Delaware law. Apparently concluding that no opinion of its own was necessary given the Chancery Court’s clear opinion below, the Delaware Supreme Court has put to rest the cause of action for deepening insolvency under Delaware law. Prior to the lower court’s decision in Trenwick, some bankruptcy and other federal courts had incorrectly predicted that Delaware would recognize this cause of action.

A Second Look At Vice Chancellor Strine’s Trenwick Opinion. Now that the Delaware Supreme Court has affirmed the Chancery Court’s decision and its reasons, the lower court’s opinion merits further consideration. As discussed in this August 2006 post on the Chancery Court’s decision, Vice Chancellor Strine held, in unequivocal terms, that there is no cause of action for deepening insolvency under Delaware law. To give context to the opinion’s legal analysis, some of its more important sections are quoted below at length:

Delaware law does not recognize this catchy term as a cause of action, because catchy though the term may be, it does not express a coherent concept. Even when a firm is insolvent, its directors may, in the appropriate exercise of their business judgment, take action that might, if it does not pan out, result in the firm being painted in a deeper hue of red. The fact that the residual claimants of the firm at that time are creditors does not mean that the directors cannot choose to continue the firm’s operations in the hope that they can expand the inadequate pie such that the firm’s creditors get a greater recovery. By doing so, the directors do not become a guarantor of success.  Put simply, under Delaware law, ‘deepening insolvency’ is no more of a cause of action when a firm is insolvent than a cause of action for ‘shallowing profitability’ would be when a firm is solvent. Existing equitable causes of action for breach of fiduciary duty, and existing legal causes of action for fraud, fraudulent conveyance, and breach of contract are the appropriate means by which to challenge the actions of boards of insolvent corporations.

Refusal to embrace deepening insolvency as a cause of action is required by settled principles of Delaware law. So, too, is a refusal to extend to creditors a solicitude not given to equityholders. Creditors are better placed than equityholders and other corporate constituencies (think employees) to protect themselves against the risk of firm failure.

The incantation of the word insolvency, or even more amorphously, the words zone of insolvency should not declare open season on corporate fiduciaries. Directors are expected to seek profit for stockholders, even at risk of failure.  With the prospect of profit often comes the potential for defeat.

The general rule embraced by Delaware is the sound one.  So long as directors are respectful of the corporation’s obligation to honor the legal rights of its creditors, they should be free to pursue in good faith profit for the corporation’s equityholders.  Even when the firm is insolvent, directors are free to pursue value maximizing strategies, while recognizing that the firm’s creditors have become its residual claimants and the advancement of their best interests has become the firm’s principal objective.

Delaware law imposes no absolute obligation on the board of a company that is unable to pay its bills to cease operations and to liquidate. Even when the company is insolvent, the board may pursue, in good faith, strategies to maximize the value of the firm. As a thoughtful federal decision recognizes, Chapter 11 of the Bankruptcy Code expresses a societal recognition that an insolvent corporation’s creditors (and society as a whole) may benefit if the corporation continues to conduct operations in the hope of turning things around.

If the board of an insolvent corporation, acting with due diligence and good faith, pursues a business strategy that it believes will increase the corporation’s value, but that also involves the incurrence of additional debt, it does not become a guarantor of that strategy’s success. That the strategy results in continued insolvency and an even more insolvent entity does not in itself give rise to a cause of action. Rather, in such a scenario the directors are protected by the business judgment rule. To conclude otherwise would fundamentally transform Delaware law.

The rejection of an independent cause of action for deepening insolvency does not absolve directors of insolvent corporations of responsibility.  Rather, it remits plaintiffs to the contents of their traditional toolkit, which contains, among other things, causes of action for breach of fiduciary duty and for fraud.  The contours of these causes of action have been carefully shaped by generations of experience, in order to balance the societal interests in protecting investors and creditors against exploitation by directors and in providing directors with sufficient insulation so that they can seek to create wealth through the good faith pursuit of business strategies that involve a risk of failure.  If a plaintiff cannot state a claim that the directors of an insolvent corporation acted disloyally or without due care in implementing a business strategy, it may not cure that deficiency simply by alleging that the corporation became more insolvent as a result of the failed strategy.

Moreover, the fact of insolvency does not render the concept of “deepening insolvency” a more logical one than the concept of “shallowing profitability.”  That is, the mere fact that a business in the red gets redder when a business decision goes wrong and a business in the black gets paler does not explain why the law should recognize an independent cause of action based on the decline in enterprise value in the crimson setting and not in the darker one.  If in either setting the directors remain responsible to exercise their business judgment considering the company’s business context, then the appropriate tool to examine the conduct of the directors is the traditional fiduciary duty ruler.  No doubt the fact of insolvency might weigh heavily in a court’s analysis of, for example, whether the board acted with fidelity and care in deciding to undertake more debt to continue the company’s operations, but that is the proper role of insolvency, to act as an important contextual fact in the fiduciary duty metric. In that context, our law already requires the directors of an insolvent corporation to consider, as fiduciaries, the interests of the corporation’s creditors who, by definition, are owed more than the corporation has the wallet to repay.

In so ruling, I reach a result consistent with a growing body of federal jurisprudence, which has recognized that those federal courts that became infatuated with the concept, did not look closely enough at the object of their ardor.  Among the earlier federal decisions embracing the notion – by way of a hopeful prediction of state law – that deepening insolvency should be recognized as a cause of action admittedly were three decisions from within the federal Circuit of which Delaware is a part.  None of those decisions explains the rationale for concluding that deepening insolvency should be recognized as a cause of action or how such recognition would be consistent with traditional concepts of fiduciary responsibility.

The Delaware Supreme Court’s adoption of the basis and reasoning of the Chancery Court’s strongly-worded opinion represents the end of the road for the deepening insolvency cause of action under Delaware law.

Hints In The Gheewalla Decision? Interestingly, in its brief order the Delaware Supreme Court dropped a footnote giving not only the citation for the Chancery Court’s decision, Trenwick America Litig, Trust v. Ernst & Young, L.L.P., 906 A.2d 168 (Del. Ch. 2006), but also an intriguing comment: "Accord North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 2007 WL 1453705 (Del. Supr. 2007)." This was a reference to its own decision of May 18, 2007 (opinion available here) holding that creditors cannot bring a direct cause of action for breach of fiduciary duty against directors of corporations that are insolvent or in the zone of insolvency.

  • As discussed in an earlier post on the Gheewalla decision, the Delaware Supreme Court opinion cited the lower court decision in Trenwick favorably, as well as the earlier Chancery Court decision in Production Resources (opinion available here), discussed in another earlier post. 
  • The "Accord" reference in its Trenwick order suggests that the Delaware Supreme Court believed that its May 2007 Gheewalla decision foreshadowed this week’s affirmance of the Chancery Court’s Trenwick decision and reasoning.

More Clarity For Directors. With the adoption of the Chancery Court’s opinion in Trenwick, and its own opinion in Gheewalla, the Delaware Supreme Court has effectively endorsed the trend in recent Chancery Court decisions to limit certain efforts to expand the liability of directors of insolvent or nearly insolvent corporations. Nearly sixteen years have passed since the Chancery Court’s decision in Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., 1991 WL 277613 (Del. Ch. 1991), introduced us to the terms "vicinity of insolvency" and "zone of insolvency." Although the Delaware Supreme Court has left some questions open, these new decisions help provide meaningful guidance on how directors of financially troubled Delaware corporations should discharge their fiduciary duties.  

Business Bankruptcy Issues Recent Developments

Have Section 363 Sale Orders Gone Too Far?

Concerned about the broad-reaching and complex forms of Section 363 asset orders being submitted for approval, this past week the U.S. Bankruptcy Court for the Northern District of California issued a set of "Guidelines re Sale Orders" as well as a form of "Model Sale Order." (Each document is available by clicking on its respective title in the prior sentence.) The Bankruptcy Court’s opening discussion of the Guidelines expresses its reasons for issuing them now:

The bankruptcy judges of the Northern District of California have become increasingly concerned about the orders they are being asked to sign on motions to approve sales of property of the estate under section 363(b) and 363(f).  Many of the proposed orders submitted:  (a) seek relief beyond the scope of the motion before the court; (b) seek to affect parties not before the court; (c) seek advisory rulings where there is no case or controversy; (d) include findings of fact that should be stated orally or in a separate memorandum; and (e) are so wordy and complex that the court has difficulty determining their meaning. 

The crafting of orders is a judicial function. Accordingly, the judges have approved a model order for motions seeking authority to sell property of the estate and motions to sell such property free and clear of liens.  The following guidelines are intended to explain how to use the model order, and what provisions the court will and will not generally approve as additions to the model order or where the parties draft their own order.  These guidelines do not apply to any separate orders approving bidding procedures, break-up fees or other matters related to the sale of property.  In addition, these guidelines do not apply in Chapter 13 cases.

The model order is not mandatory, but the judges will use the model order on their own motion where parties vary from these guidelines without sufficient cause and explanation. 

In the event that a party submits a sale order that deviates from these guidelines, the party shall, unless otherwise instructed by the court, submit a declaration to the court in which the party identifies the provisions that vary from these guidelines and sets forth the justification therefore.

(Emphasis in original.) Many bankruptcy lawyers who practice regularly in the Northern District of California, with divisions in San Francisco, San Jose, Oakland, and Santa Rosa (and courthouses in Eureka and Salinas), have already understood the prevailing view of the bankruptcy judges on these issues. However, the new guidelines help clarify matters for everyone facing these issues in the Northern District of California. 

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.

The Sale Order. For a buyer of assets in a Section 363 bankruptcy sale, a big question is what type of factual findings and legal rulings will the bankruptcy court include — or refuse to include — in the order approving the sale. Buyers typically desire that the sale be ordered "free and clear" of all liens, claims, interests, and encumbrances, rather than only certain ones specifically identified in the notice of the sale motion. They also prefer to have findings added to the order on issues such as fair value paid and no successor liability, and often ask for an injunction against actions affecting the buyer that are inconsistent with the sale order’s findings and provisions.

Big Differences From District To District. As bankruptcy lawyers know, courts in different districts around the country have taken surprisingly divergent views on what is, and is not, appropriate in Section 363 sale orders.

  • It’s hard not to notice the striking differences between the new Model Sale Order from the Northern District of California and examples of sale orders entered over the past few years by bankruptcy courts in the District of Delaware (example here), the Southern District of New York (example here), and the Northern District of Illinois (example here), three courts where a number of large Chapter 11 cases have been filed. 
  • The new Guidelines issued by the Northern District of California appear to be in reaction to the submission of sale orders more in keeping with the accepted practice in Delaware and New York than in Northern California.

Although one wonders if the Northern District of California’s approach will spread to other courts, the more likely scenario is that each district will continue to follow its own path.

Business Bankruptcy Issues The Financially Troubled Company

Section 363 Sales: Interesting Article Takes A Further Look

David Powlen, Managing Director and Partner at Western Reserve Partners LLC, has an interesting article on the Turnaround Management Association website entitled "Bargains Await Buyers Skilled At Navigating Section 363 Minefields." It gives a good overview of the range of issues that arise in the context of a sale under Bankruptcy Code Section 363. Among the article’s observations:

  • Unlike traditional private company M&A deals, Section 363 sales take place in the "fishbowl" of a bankruptcy proceeding;
  • Although the bankruptcy process generally leads the debtor to seek an auction, some typical M&A bidders may not participate in a bankruptcy sale, potentially reducing the competition to a stalking horse bidder;
  • Compensating for the usual lack of representations and warranties in an asset purchase agreement with a bankrupt company is the court’s sale approval order, which generally approves a sale free and clear of liens, claims, and interests; and
  • A Section 363 sale may not be free of every claim or interest, however, as certain environmental and product liability claims may nevertheless pass to the buyer. 

The article also includes a helpful chart giving a graphic presentation of the relative risks and benefits of an out-of-court sale, a Section 363 sale, and the less common sale through a Chapter 11 plan of reorganization. For more on these issues, you may also be interested in this earlier post and linked article on buying assets from a financially distressed company.

Business Bankruptcy Issues Recent Developments

The “Ride Through” Doctrine Rides Again: Ninth Circuit BAP Lets A License Agreement Ride Through Chapter 11

In a June 18, 2007 decision in In re J.Z. L.L.C. (available here), the Bankruptcy Appellate Panel (BAP) of the U.S. Court of Appeals for the Ninth Circuit faced an interesting question: Did the so-called "ride through" doctrine from the old Bankruptcy Act of 1898 survive enactment of the Bankruptcy Code in 1978? The BAP’s introduction to the decision sums up its answer:

We confront the puzzle of the status of an executory contract that was neither assumed nor rejected during a chapter 11 case in which there was a confirmed plan that did not involve transfers of property of the estate or creation of new entities. We conclude that the “ride through” doctrine developed under the former Bankruptcy Act retains vitality in chapter 11 cases when the debtor continues operating and does not change form.

After a chapter 11 case was closed, the reorganized debtor sued in state court to enforce a license that it had granted prepetition regarding the use of its manufacturing technology. The state court declined to act without a bankruptcy court ruling that the license, which had been neither assumed nor rejected during the chapter 11 case, remained in effect. The bankruptcy court ruled that the license contract survives under the “ride through” doctrine, that the debtor has standing to enforce the contract because all property of the estate vested in the debtor on confirmation, and that the reorganized debtor should not be judicially estopped. We AFFIRM.

Executory Contracts And Bankruptcy. I have previously discussed the importance of executory contracts in bankruptcy, and specifically how licenses of intellectual property are treated. Both of those posts were premised on the bankruptcy court being asked to decide whether an intellectual property license could be assumed, assumed and assigned, or rejected during the bankruptcy. This case, however, presented a very different situation in which the Chapter 11 debtor did not take any action during the Chapter 11 case to assume or reject the executory contract (here a license agreement permitting the non-debtor party to manufacture, promote, and sell a horizontal grinder on an exclusive basis for five years). In addition, although aware of the bankruptcy case, the non-debtor party to the contract also did not seek to force a decision on assumption or rejection pursuant to Section 365(d)(2).

The BAP’s Reasoning. The BAP’s 28-page decision carefully analyzes the issues raised in the case and makes a number of interesting conclusions.

  • First, not only did the debtor neither assume nor reject the license agreement, it also failed to list it on its bankruptcy schedules (specifically Schedule G). Nevertheless, the BAP held that the non-debtor licensee’s failure to disclose it to the Bankruptcy Court or creditors left it "in the grandstand and not on the playing field" on its argument that the debtor should lose the right to enforce the agreement.
  • Second, even though the license agreement was unscheduled, once the debtor’s Chapter 11 plan was confirmed, all property of the estate — including this unscheduled asset — revested in the reorganized debtor under Section 1141(b) of the Bankruptcy Code.
  • Third, while judicial estoppel can sometimes apply to limit the debtor’s ability to sue on an unscheduled asset,  the BAP decided against applying judicial estoppel here, noting that when creditors could be harmed by such limits one "should not become so angry at a debtor that a creditor is taken out and shot." The BAP did acknowledge that the state court hearing the debtor’s lawsuit against the licensee could reach a different conclusion.
  • Fourth, under the language and structure of the Bankruptcy Code, an "executory contract that is not assumed in a chapter 11 case is not ‘deemed rejected.’ As a matter of straightforward statutory construction, it follows that some other alternative, i.e., ‘ride through,’ must be available."
  • Fifth, the "ride through" or "pass through" doctrine was well established under the Bankruptcy Act of 1898 and nothing in the Bankruptcy Code of 1978 requires a conclusion that Congress intended to disturb that existing doctrine. In addition, the lack of clarity over which contracts are executory and which are non-executory (and thus not subject to assumption or rejection) bolsters the view that a "ride through" alternative exists for contracts.

For more background on the Bankruptcy Court’s decision below (available here), affirmed by the BAP, be sure to read Warren Agin’s December 2006 post on his Tech Bankruptcy Blog, which gives his always insightful perspective on these IP and bankruptcy issues. 

Significance Of A BAP Decision. It’s worth noting that unlike a U.S. Court of Appeals, the BAP is made up of bankruptcy judges only, not federal circuit judges. Given a BAP’s place in the judicial system’s hierarchy, its decisions are not given the same precedential weigh as U.S. Court of Appeals decisions. This means that it’s possible that the U.S. Court of Appeals for the Ninth Circuit could reach a different, and overruling, conclusion. However, the BAP’s decision in this case is well-reasoned and three other circuits (the First, Second, and Fifth) have also ruled that the ride through doctrine still applies today. This makes the BAP’s decision of special interest.

A Strategic Use Of The "Ride Through" Doctrine? As discussed in an earlier post on assumption of IP licenses, in several circuits a debtor cannot even assume many in-licenses of intellectual property without the licensor’s consent.

  • In those circuits, a debtor may consider whether it could retain licenses simply by choosing to have them "ride through" the Chapter 11 case, neither moving to assume the license nor (the debtor hopes) having the licensors move to compel rejection. This scenario makes the old "ride through" doctrine of particular interest, especially if the debtor licensee has not defaulted under the agreement and is seeking only to keep the license agreement after reorganizing in Chapter 11.
  • While it’s true that the occasional executory contract may slip through without a formal decision to assume or reject, it’s the prospect of a debtor being able to use the doctrine as alternative way of preserving valuable intellectual property licenses that has bankruptcy lawyers giving the "ride through" doctrine a closer look.

Stay tuned, but the BAP’s decision in In re JZ L.L.C. may encourage more such efforts in the future.

Business Bankruptcy Issues Recent Developments

Florida Bankruptcy Court Considers The Supreme Court’s Travelers Decision And Refuses To Allow Post-Petition Attorney’s Fees To An Unsecured Creditor

In March 2007, the U.S. Supreme Court overruled the so-called Fobian rule in the Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. decision. (Click here for a copy of the decision.) That rule, named for the decision by the United States Court of Appeals for the Ninth Circuit in a case called In re Fobian, 951 F.2d 1149 (9th Cir. 1991), had barred unsecured creditors from recovering as part of their unsecured claim attorney’s fees incurred post-petition litigating bankruptcy issues. 

The Open Question. As discussed in an earlier post, although the Supreme Court dispatched the Fobian rule, in Travelers it did not decide whether an unsecured creditor could actually recover its attorney’s fees. Among other issues, it left for another day the issue of whether Section 506(b) of the Bankruptcy Code, which expressly allows attorney’s fees to oversecured creditors, precludes recovery of post-petition attorney’s fees as part of an unsecured claim.

A New Decision From Florida. Jordan Bublick has an interesting post on his Miami Florida Bankruptcy Law blog about a July 6, 2007 decision in the In re Electric Machinery Enterprises, Inc. Chapter 11 case. In the decision, the court held that an unsecured creditor is not permitted to add post-petition attorney’s fees and costs to its unsecured claim. A copy of the decision, by Judge Michael G. Williamson of the the U.S. Bankruptcy Court for the Middle District of Florida, is available here. As Jordan points out, the Florida bankruptcy court held that the pre-Travelers majority rule denying unsecured creditors post-petition attorney’s fees was still good law. Among the reasons the court cited:

  • Section 506(b)’s language permits only oversecured creditors to receive interest and fees, and this effectively excludes recovery by unsecured creditors.
  • The reasoning of the Supreme Court’s decision in United Savings Ass’n v. Timbers, 484 U.S. 365 (1988), that post-petition interest can only be paid to secured creditors with the benefit of an equity cushion, applies to attorney’s fees as well.
  • Section 502(b) requires the amount of a claim to be determined "as of the date of the filing of the petition," before post-petition fees have accrued.
  • Allowing fees to contract creditors would be inequitable because tort and many trade creditors, who lack the ability to recover attorney’s fees, would have their relative recovery diminished.

Judge Williamson called out another reason for his decision:

Furthermore, the Court is particularly mindful of the practical impact a contrary ruling would have on the administration of a bankruptcy case. There would be no finality to the claims process as bankruptcy courts would constantly have to revisit the issue of the amount of claims to include ever-accruing attorneys’ fees. The ‘cash registers’ would ring on a daily basis, as attorneys for unsecured creditors that were active in the case would continually be filing new claims or seeking to reconsider previously allowed claims in order to add post-petition attorneys’ fees and costs. Essentially, there could be no finality to the claims resolution process if the ever-accruing fees and costs attendant to the representation of unsecured creditors were allowed as part of an unsecured claim.

An Earlier California Bankruptcy Court Decision. Interestingly, the Florida bankruptcy court did not cite to the In re Qmect, Inc. decision, issued by the U.S. Bankruptcy Court for the Northern District of California in May 2007 and discussed in this earlier post. In that decision, the California bankruptcy court took the opposite view. It held that an unsecured creditor could recover, as part of its unsecured claim, post-petition attorney’s fees if its contract with the debtor provided for recovery of such fees. Adopting a different view of the bankruptcy policies at issue, that court held:

The strongest rationale for implying a prohibition on the inclusion of post-petition attorneys’ fees in a unsecured creditor’s pre-petition claim is that, unless the debtor is solvent, the unsecured creditor’s augmented claim will diminish the dividend to other unsecured creditors. However, a similar effect flows from allowing secured creditors to include their post-petition attorneys’ fees in their secured claims. While equality of distribution is one of the basic tenets of bankruptcy law, another important policy in bankruptcy is the preservation of nonbankruptcy legal rights except to the extent necessary to facilitate the purpose of the bankruptcy proceeding. Absent a clear provision of the Bankruptcy Code modifying a creditor’s nonbankruptcy legal rights, the Court concludes that those rights should be deemed to be left intact.

More Decisions To Follow. Bankruptcy courts are now beginning to address whether unsecured creditors can recover post-petition attorney’s fees in the wake of the Travelers decision. These two early decisions have reached completely different conclusions. More decisions will undoubtedly follow as creditors with attorney’s fees provisions in their contracts seek to include post-petition fees in their unsecured claims. With the issue far from settled, be sure to stay tuned.