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Business Bankruptcy Issues Recent Developments

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

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

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

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

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

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

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

*           *           *

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

*          *          *

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

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

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

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

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

*         *          *

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

[Footnote 5]

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

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

Business Bankruptcy Issues Recent Developments

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

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

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

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

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

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

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

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

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

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

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

Business Bankruptcy Issues Recent Developments

Assumption Of Intellectual Property Licenses In Bankruptcy: Are Recent Cases Tilting Toward Debtors?

Executory contracts present a host of interesting issues in bankruptcy cases. This is especially true when the executory contract involves a license of intellectual property (or "IP"). In the past I’ve devoted several posts to the topic, including how IP licenses are treated in bankruptcy and the unique issues presented when a trademark licensee or trademark licensor files bankruptcy. 

In this post, I’ll drill down a bit deeper into the question of how courts have analyzed whether a Chapter 11 debtor can assume or assign an IP license to a third party over the IP licensor’s objection. If you’re new to the topic, be forewarned: the courts are all over the map on the issue. For those who’d like a scorecard, you’ll find a link to a circuit-by-circuit chart in the "Where Does Your Court Stand?" section toward the end of this post.

Assumption And Assignment. In bankruptcy parlance, assumption means that the debtor gets to keep the license. Usually, debtors are allowed to exercise their business judgment when deciding whether to assume or reject (read: breach and stop performing) an executory contract, as well as to assume and assign one to a third party. However, Section 365(c)(1) of the Bankruptcy Code puts a limit on a debtor’s ability to assign executory contracts, and perhaps even to assume them, when "applicable law" gives the non-debtor party to the contract the right to refuse to deal with someone else.

The Key Bankruptcy Code Section. Since Section 365(c)(1) is so important to this debate, it bears careful review. Here’s what it says:

(c) The trustee may not assume or assign any executory contract or unexpired lease of the debtor, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties, if—

(1)(A) applicable law excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties; and

(B) such party does not consent to such assumption or assignment.

What’s "Applicable Law?" Collectively, a number of courts have interpreted the phrase "applicable law" to mean patent, copyright, and trademark law, holding that these federal intellectual property laws excuse a non-debtor party to an IP license from accepting performance from or rendering performance to an entity other than the debtor in bankruptcy. As a result, these courts have held that an IP licensor who does not consent can successfully block a debtor from assigning a patent, copyright, or trademark license to a third party during a bankruptcy case. This rule applies with greatest force to non-exclusive IP licenses but may also apply to certain exclusive licenses too. For more on this subject, read Professor Menell’s article on the bankruptcy treatment of IP assets, which I discussed last month.

What Constitutes Consent? Consent to assumption or assignment of an IP license can come in three ways. First, the licensor can affirmatively consent in writing after a bankruptcy case has been filed. Second, a licensor that fails to object after a motion has been filed seeking to assume, or to assume and assign, a license agreement will likely be deemed to have consented. Third, a number of license agreements expressly permit assignment under certain circumstances and many, but not all, courts will treat such provisions as providing the consent required under Section 365(c)(1)(B). A provision sometimes found in license agreements allows assignment in conjunction with a sale of all or substantially all of the assets of the licensee. Warren Agin of the Tech Bankruptcy blog wrote about a recent Massachusetts case (in which I represented the buyer) enforcing a similar provision.

Hypothetical Versus Actual Test. If a debtor cannot assign an IP license without consent of the licensor, can it at least assume the license? That question has led courts to examine ever so closely the first seven words of Section 365(c): "The trustee may not assume or assign…" 

  • When the statute says that the trustee may not assume or assign an IP license, does the word "or" really mean "and" too?
  • Put differently, what happens when a debtor is only trying to assume (keep) an IP license and is not actually trying to assign it? Does the Bankruptcy Code language mean that it can neither assume nor assign the license or does it only mean that the debtor cannot assign the license?
  • That, in a nutshell, is the difference between the so-called "hypothetical test" (which reads Section 365(c)(1)’s language as asking whether the debtor hypothetically could assign the license even if it’s only proposing to assume it) and the "actual test" (which interprets the statute’s language as asking only what the debtor is actually proposing to do).
  • The U.S. Courts of Appeals for three circuits have adopted the hypothetical test. The Ninth Circuit (covering California, Arizona, and a number of other Western states), the Third Circuit (which includes Delaware, the venue of many Chapter 11 cases), and the Fourth Circuit (covering Virginia, West Virginia, Maryland, and North and South Carolina), have held that Section 365(c)(1) gives most IP licensors a veto right over proposals by a Chapter 11 debtor to assign — and even to assume — IP licenses.
  • The leading hypothetical test decision is from the Ninth Circuit in In re Catapult Entertainment, Inc.,165 F.3d 747 (9th Cir. 1999). In Catapult, the court built on an earlier decision holding that a non-exclusive patent license could not be assigned without the patent holder’s consent and, adopting the hypothetical test, held that such a patent license also could not be assumed over the patent holder’s objection.
  • Leading the charge for the actual test is the First Circuit’s decision in Institut Pasteur, et al. v. Cambridge Biotech Corporation, 104 F.3d 489 (1st Cir. 1997). That circuit includes Massachusetts, among other states.

A Third Test From New York. Despite this predominantly licensor-favorable backdrop, in several recent decisions courts have sided with Chapter 11 debtors. This emerging trend is noteworthy because two of those decisions come from the Southern District of New York. That’s where many of the largest Chapter 11 bankruptcy cases tend to be filed, such as Enron, WorldCom, Delphi Corporation, Dana Corporation, Northwest Airlines, and Delta Airlines, to name a few, making it perhaps the most important bankruptcy court in the country.

The New York Cases: Footstar And Adelphia. In a 2005 decision in In re Footstar, Inc., 323 B.R. 566 (Bankr. S.D.N.Y. 2005), the Bankruptcy Court for the Southern District of New York broke new ground. Although it did not involve intellectual property licenses, the case put Section 365(c)(1)’s language front and center and came up with a third way of analyzing this critical section. Judge Adlai Hardin adopted a new "literal" reading of section 365(c)(1), one that he found was "entirely harmonious with both the objective sought to be obtained in Section 365(c)(1) and the overall objectives of the Bankruptcy Code, without construing ‘or’ to mean ‘and.’" His approach? Section 365(c)(1)’s use of the word "trustee" does not (as other courts had taken for granted) include the debtor or debtor in possession. As such, the right of the non-debtor party to object to assignment does not by itself affect the right of the debtor in possession (as opposed to a trustee) to assume an executory contract.

In January 2007, Judge Robert Gerber, also of the Bankruptcy Court for the Southern District of New York, faced the same issue in the Adelphia Communications Chapter 11 case. In his decision on the Section 365(c)(1) issue, Judge Gerber expressly rejected the cases following the "hypothetical" test as "incorrectly decided," and instead embraced Judge Hardin’s Footstar decision, describing it as "consistent in outcome with the decisions of" those courts following the "actual" theory. In a footnote, Judge Gerber stated: "[W]here there is no Second Circuit authority, [the Bankruptcy Court for the Southern District of New York] follows the decisions of other bankruptcy judges in this district in the absence of clear error. But to say that the Footstar decisions should be followed under that standard would be faint praise here. In this Court’s view, Judge Hardin’s analysis in those decisions was plainly correct." This suggests that other judges in the Southern District of New York may follow suit, at least unless the Second Circuit were to rule otherwise.

For a detailed analysis of the Footstar decision, be sure to read the article by Cooley Godward Kronish partners Jay Indyke and Richard Kanowitz, and associate Brent Weisenberg, who were directly involved in the case, which appears in the April 2007 issue of the Journal of Bankruptcy Law and Practice. It’s called “Ending the Hypothetical’ vs.‘Actual’ Test Debate: A New Way to Read Section 365(c)(1),” 16 J. BANKR. L. & PRAC. 2 Art. 2 (2007).

Another Circuit Follows The Actual Test. The Fifth Circuit (covering Texas, Louisiana, and Mississippi) also jumped into the fray, albeit interpreting a different but related section, Section 365(e), with its February 2006 decision in Bonneville Power Administration v. Mirant Corp., 440 F.3d 238 (5th Cir. 2006). Upon the Chapter 11 bankruptcy of Mirant Corporation, the Bonneville Power Administration (BPA) attempted to terminate its executory contract with Mirant based on an ipso facto clause, a provision that makes a bankruptcy filing a breach of contract. While these provisions generally are not enforced, the BPA relied on Section 365(e)(2)(A), which closely mirrors the language of Section 365(c)(1)(A), and argued that it could terminate the contract because applicable law — the federal Anti-Assignment Act, 41 U.S.C. Section 15 — excused it from accepting performance from or rendering performance to an entity other than the debtor or debtor in possession. After a lengthy analysis, the Fifth Circuit joined the First Circuit (rejecting the position of the Third, Fourth and Ninth Circuits) and expressly adopted the "actual" test. The Fifth Circuit held that the ipso facto clause was null and void under Section 365(e)(1) because Mirant, the debtor in possession, was not actually planning to assign the contract. For a more detailed discussion of the case, be sure to check out Steve Jakubowski’s excellent post over at the Bankruptcy Litigation Blog.

Where Does Your Court Stand? With courts coming out on different sides of the hypothetical versus actual test issue, and with the Footstar and Adelphia courts advancing yet another view of Section 365(c)(1), you might be looking for a chart to keep up with all the decisions. Well, as part of a presentation I made last month to the Commercial Law and Bankruptcy Section of the Bar Association of San Francisco (and with a big assist from Brian Byun, an associate in the Bankruptcy & Restructuring Group at my firm who also contributed to this blog post), we put together just such a circuit-by-circuit chart of the various decisions. You may find this circuit map useful when reviewing the chart. 

How Often Does This Come Up? The answer is frequently. Most corporate debtors have critical in-licenses of intellectual property and either need to assume them or, as part of a Section 363 asset sale, assume and assign them to the buyer. IP licensors are understandably protective of their intellectual property. Still, even when they have the right to object to assumption or assignments, in my experience many IP licensors will agree to allow debtors to assume, and sometimes even to assign to a buyer, important licenses. There may be an added cost, either in the form of a fee or the imposition of conditions to protect the licensor’s rights. That said, not all licensors will consent to assumption or assignment. In hypothetical test jurisdictions, debtor licensees may end up losing their license rights.

Location, Location, Location. This phrase is most often associated with real estate, but it could just as well apply to the venue of a bankruptcy case when assumption of an IP license is at issue. A debtor’s ability to assume an IP license over the objection of the licensor can be radically different depending upon where the bankruptcy case is pending. Perhaps the developing circuit split over Section 365(c)(1) will lead the U.S. Supreme Court to agree to take up the issue. Until that happens, or Congress amends the law, what a debtor can do with its IP licenses will continue to depend, in no small part, on where it files bankruptcy. 

Business Bankruptcy Issues Recent Developments

Proof Of Claim And Other Bankruptcy Forms Revised To Reflect April 1, 2007 Dollar Amount Adjustments

As reported in this post last month, certain dollar amounts in the Bankruptcy Code were increased effective April 1, 2007. The dollar amount changes meant that some of the official bankruptcy forms, most notably the proof of claim form and the voluntary petition, had to be revised as well.

After I put up that post, the Administrative Office of the United States Courts (known in the trade as "the AO") made the revised forms available and released a formal notice of the dollar amount adjustments. Copies of the revised forms — with handy arrows pointing out each place where they were revised — are attached to the notice.

Of course, you’ll need to get the forms in blank to use in bankruptcy cases. If you don’t have special bankruptcy form software, a number of the official bankruptcy forms have been designed to allow you to type in information or select choices from drop-down menus before printing the form. Printing is the only way to go because the form won’t let you save your changes. 

If you follow the links above you’ll be able to access blank copies of the revised forms from the AO’s website. That way, you’ll be sure to have the most up-to-date versions.

Business Bankruptcy Issues Recent Developments The Financially Troubled Company

Defending A Preference: Ninth Circuit Holds That Even First Time Transactions Can Be In The “Ordinary Course”

In a decision issued on April 3, 2007 in the In re: Ahaza Systems, Inc. case, the Ninth Circuit held that even first time transactions can qualify for the "ordinary course of business" defense to preferences. A copy of the Court of Appeal’s decision is available here.

The Bankruptcy Preference. As a quick refresher, preferences are payments or other transfers made in the 90 days prior to a bankruptcy filing, on account of antecedent or pre-existing debt, at a time when the debtor was insolvent, that allow the transferee (the preference defendant) to be "preferred" by recovering more than it would have had the transfer not been made and the defendant instead had simply filed a proof of claim for the amount involved. The 90-day reachback period is extended to a full year prior to the bankruptcy petition for insiders such as officers, directors, and affiliates.

Pre-BAPCPA Statute. The ordinary course of business defense, designed to protect parties who engage in normal transactions with a financially troubled business, is one of the most common defenses available to preference recipients. The Ninth Circuit examined it under the version of the preference statute, Section 547 of the Bankruptcy Code, as it existed before the 2005 amendments made in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (known as BAPCPA). This pre-BAPCPA statute, specifically Section 547(c)(2), provided that a trustee could not avoid a transfer as a preference

to the extent that such transfer was —

(A) in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee;

(B) made in the ordinary course of business or financial affairs of the debtor and the transferee; and

(C) made according to ordinary business terms.

The Court’s focus was on subsection (A), the "debt" issue. Usually, parties have a series of contracts or purchase orders, as well as a payment history, that gives context to the ordinary course of business between them. In this case, however, the transaction that led to the allegedly preferential payments was their first one. The Court faced the question of whether a debt can be considered as having been incurred in the ordinary course of business of the debtor and the preference defendant when there had been no other past transactions to which it could be compared.

Court Looks To Past Practices With Other Similar Parties. The Court’s answer was yes, holding that a preference defendant can indeed assert the ordinary course of business defense involving a debt created by the first contract or transaction between the parties. However, the Ninth Circuit articulated a special rule when a "first time" debt is involved:

[W]hen we have no past debt between the parties with which to compare the challenged one, the instant debt should be compared to the debt agreements into which we would expect the debtor and creditor to enter as part of their ordinary business operations. Consistent with Food Catering [971 F.2d 396 (9th Cir. 1982)], however, this analysis should be as specific to the actual parties as possible. Thus, we hold that to fulfill § 547(c)(2)(A), a first-time debt must be ordinary in relation to this debtor’s and this creditor’s past practices when dealing with other, similarly situated parties. Only if a party has never engaged in similar transactions would we consider more generally whether the debt is similar to what we would expect of similarly situated parties, where the debtor is not sliding into bankruptcy.

Both Original And Restructured Agreements Are Relevant. On a related point, since the first transaction here was an agreement that was later restructured to give the debtor more time to pay, the Ninth Circuit also held that both the original and revised agreement should be evaluated for ordinariness.

Ruling Still Important Under BAPCPA. BAPCPA revised the ordinary course of business defense so that Section 547(c)(2) now provides that a payment or other transfer cannot be avoided

to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was—

(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or

(B) made according to ordinary business terms.

Although different, the current statute still makes the issue decided in the In re: Ahaza Systems case, whether the debt was incurred in the ordinary course of business, a requirement. The major change is that the statute now allows the defense to be established by additionally showing that payments were made either (A) in the ordinary course of business of the parties or (B) according to ordinary business terms, rather than both as under the pre-BAPCPA version.

How Hard To Meet? Having established the new test, the Court then reversed the granting of summary judgment to the defendant because it found the proof presented was inadequate. This suggests that although the Ninth Circuit will permit preference defendants to assert the ordinary course of business defense on first time transactions, some defendants may face a challenge in meeting that standard.

Business Bankruptcy Issues Recent Developments

New Article On How Distressed Debt Investors Are Preparing For The Next Economic Downturn

The DealBook blog from the New York Times has an interesting post entitled "Stocking Up For A Storm." It describes how certain investment banks have been expanding their distressed debt businesses, believing that the length of the current "good times" period may actually lead to an increase in the level of distress when the economy finally turns. 

The DealBook post points readers to a new article in The Economist on so-called vulture investors. Entitled "The Vultures Take Wing," the article discusses the view of many investors and insolvency professionals that, after a drought of restructurings, a new wave of bankruptcies and defaults may not be too far off. When the problems come, they will likely be even more complex than in past cycles. Not only have very active hedge funds taken a much greater role in recent years, but many companies now have an additional tranche of secured debt in the form of the increasingly popular second lien loans.

While corporate restructurings and Chapter 11 bankruptcy cases have always been complex, when the next surge in defaults hits these trends are likely to present even more challenges — and perhaps opportunities — for both debtors and creditors.

Business Bankruptcy Issues Recent Developments

Northwest Airlines Ad Hoc Committee Files Second Appeal On Disclosure Of Trading Details

As reported last week, the Ad Hoc Committee of Equity Security Holders in the Northwest Airlines case, a group made up chiefly of hedge funds, recently complied with the Bankruptcy Court’s earlier orders and filed a Rule 2019 statement disclosing details of their trades. Having made the filing, it wasn’t clear whether the Ad Hoc Committee would continue to appeal from the Bankruptcy Court’s decisions compelling the disclosure. An answer to that question came late in the day on Monday, March 26.

New Appeal Filed. Late Monday, the remaining membership of the Ad Hoc Committee of Equity Security Holders filed a second notice of appeal, this time from the Bankruptcy Court’s original February 26, 2007 decision requiring the detailed statement to be filed. A copy of the new notice of appeal is available here. An earlier notice of appeal was filed from the Bankruptcy Court’s March 9, 2007 order denying a motion to file the Rule 2019 statement under seal. It appears that the earlier appeal will be pursued as well.

No Stay Pending Appeal. As previously reported, at a March 15, 2007 hearing the Bankruptcy Court also denied the Ad Hoc Committee’s motion for a stay pending appeal. However, the Ad Hoc Committee got until March 25, 2007 to seek a stay from the United States District Court for the Southern District of New York. (Here’s the Bankruptcy Court’s order on the stay issue, which was filed only last Friday.) Despite the temporary reprieve, the Ad Hoc Committee apparently decided against seeking a stay pending appeal and instead went ahead and filed the updated Rule 2019 statement and then a new appeal.

The Disclosure Issue Moves To Another Court. With the new appeal filed Monday, this issue should be headed to the District Court for briefing and argument in the coming months. It’ll be interesting to see whether the District Court, sitting as an appellate court, has any different reaction to the disclosure issue. Stay tuned for future developments.