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Business Bankruptcy Issues Recent Developments

Appointment Of Interim Trustee Before Section 546’s Two-Year Statute Of Limitations Expires Insufficient To Extend Period For Bringing Preference Actions

Scott Riddle over at the Georgia Bankruptcy Law Blog has an informative post on the decision by the U.S. Court of Appeals for the Third Circuit last week in the American Pad & Paper Company case. The case involved Section 546(a) of the Bankruptcy Code, which extends the standard two-year statute of limitations for bringing preference and other avoidance actions by up to one additional year if, before the two-year period expires, a trustee is appointed or elected.

The Third Circuit’s Holding. In short, the Third Circuit decided that the appointment during this two year window of an interim trustee under Section 701 of the Bankruptcy Code does not trigger the additional one year extension. Instead, the Third Circuit held that Section 546(a)(1)(B) specifically refers to Section 702 of the Bankruptcy Code and not Section 701. As a result, in a Chapter 7 case, a permanent trustee must be appointed or elected under Section 702, before the two-year period expires, for the one year extension to kick in. 

When Does This Come Up? Although not an everyday occurrence, this situation can arise when a case originally filed under Chapter 11 is converted to Chapter 7 after almost two years. In the American Pad & Paper Company case, the selection of a permanent trustee under Section 702 was delayed (the creditors decided to elect a permanent trustee instead of letting the interim trustee become the permanent trustee), resulting in the expiration of the two-year statute of limitations before it could be extended for one additional year. The impact? The court held that the permanent trustee’s preference actions were all time-barred.

What Creditors Should Watch For. Defendants in preference or other avoidance actions in cases that were converted to Chapter 7 after a couple of years in Chapter 11 should carefully review the sequence of events surrounding the trustee’s appointment to see if the statute of limitations expired. Likewise, if a Chapter 11 case converts to Chapter 7 more than two years after the case was originally filed (technically, after the "order for relief" was entered), and no preference actions were brought in the Chapter 11 case, the trustee will be barred by the statute of limitations from bringing any avoidance actions. 

Business Bankruptcy Issues Recent Developments

Do Hedge Funds Have To Disclose Their Trades If They Form A Bankruptcy Committee?

In recent years, hedge funds and other investors in distressed debt or the equity securities of bankrupt companies have taken active roles in Chapter 11 bankruptcy cases. Often, these investors form unofficial or "ad hoc" committees. This post reports on a recent decision by a New York bankruptcy court in the Northwest Airlines case which, if ultimately enforced, could have a major impact on hedge funds, ad hoc committees, and Chapter 11 cases.

Ad Hoc Committees. Unofficial or ad hoc committees, much like official committees of unsecured creditors, equity security holders, retirees, or other constituencies, typically hire counsel and file motions and other pleadings during the course of a bankruptcy case. By acting as a group, the committee’s members not only share the costs of participating in the bankruptcy case but also have the ability to wield greater influence by acting collectively instead of on an individual basis.

The Rule 2019(a) Statement. After making an appearance in a bankruptcy case, these committees, their counsel, or both will typically file what’s known as a "Rule 2019(a) Statement." This is a public filing required by Rule 2019(a) of the Federal Rules of Bankruptcy Procedure, the set of procedural rules which, together with the United States Bankruptcy Code itself, govern the conduct of bankruptcy cases. Rule 2019(a) provides, in part, as follows:

[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.

The Ad Hoc Committee In Northwest Airlines. While seemingly a dry and arcane bankruptcy rule, it has recently become anything but in the Northwest Airlines Corporation Chapter 11 case. In January 2007, an Ad Hoc Committee Of Equity Security Holders first made an appearance in the case. Its thirteen members include hedge funds and other investment entities that collectively own more than 19 million shares of Northwest Airlines stock and approximately $265 million in claims. The Ad Hoc Committee sought discovery in the case and asked that an official committee of equity security holders be appointed (a request it recently withdrew). 

The Debtors Seek Additional Disclosure. In the course of litigating certain disputes, Northwest Airlines filed a motion seeking, among other relief, an order under Rule 2019 requiring the Ad Hoc Committee to disclose more detailed information about the amounts of claims or stock owned by the Committee’s members, when they acquired it, how much they paid for it, and when they sold or otherwise disposed of any of their holdings. In support, Northwest Airlines made this argument:

The Ad Hoc Committee remains a mystery to the Debtors and to all the other constituencies in the Debtors’ cases, yet it seeks to make an impact at this late stage of the Debtors’ reorganization. Without the proper disclosures, the Court should refuse to allow the Ad Hoc Committee to continue to cause serious delays to the Debtors’ reorganization efforts, and operate outside of the Bankruptcy Code and the Bankruptcy Rules.

The Ad Hoc Committee Opposes The Motion. The Ad Hoc Committee opposed the motion on several grounds, including that its Rule 2019 statement was proper in form, that the purpose of the rule is only to ensure that plans of reorganization are negotiated and voted on by those authorized to act for the real parties in interest, and that this purpose was satisfied by the form of the statement already filed.

The Northwest Airlines Court’s Rule 2019 Decision. On February 26, 2007, Judge Gropper issued his decision requiring the Ad Hoc Committee to file a Rule 2019 statement that provided the detailed information the Debtors had sought in their motion. The Court ruled that Rule 2019 applies to ad hoc or unofficial committees and rejected the Ad Hoc Committee’s argument that the prior Rule 2019(a) statement, which did not give detailed information about dates of trades and prices paid, was adequate.

The Ad Hoc Committee’s Further Motion. On March 1, 2007, the Ad Hoc Committee filed a motion for an order allowing the additional Rule 2019 statement to be filed under seal but asking that the Court stay its prior order pending further hearing. The Ad Hoc Committee argued that the trading information required under the Court’s order represented trade secrets and confidential commercial information and that, to its knowledge, no other committee or party had been required to file such information publicly in any other Chapter 11 case. The Ad Hoc Committee contended that requiring its members to make that disclosure would irreparably damage them, as other investors were not required to make such disclosures but some might use that information to inform their own trades.

The Court Grants The Ad Hoc Committee’s Motion. Later that same day, the Court granted the Ad Hoc Committee’s motion. The Court set a fast briefing schedule and a further hearing for March 7, 2007. I will plan to report on the resolution of that motion after the Court makes its decision.

Why This Matters. While disputes over disclosure are not always worthy of motions, multiple hearings, and blog postings, this case is different. Hedge funds and other buyers of distressed debt or stock in bankrupt companies carefully guard their trading information, especially the price they’ve paid. If ad hoc committee members will be required to disclose this information publicly, or perhaps even privately, they may choose not to participate in unofficial committees or generally may be dissuaded from becoming active participants in Chapter 11 cases. Hedge funds and other distressed debt traders have been deploying enormous amounts of money through second lien lending in distressed situations and directly in bankruptcy cases through the purchase of claims and stock. They have also regularly taken very active roles in major Chapter 11 cases. Any ruling with the potential to reverse or impact this trend would be big news indeed.

Business Bankruptcy Issues Recent Developments

The Supreme Court’s Recent Decision In Marrama: Any Insight Into Business Bankruptcy Issues?

On Wednesday the U.S. Supreme Court issued its decision in Marrama v. Citizens Bank of Massachusetts. The Supreme Court answered the question of whether an individual has an absolute right to convert a Chapter 7 bankruptcy case to a Chapter 13 "wage earner" bankruptcy case or whether that right can be conditioned on the absence of bad faith. This blog is focused on business bankruptcy issues, but knowing how the Supreme Court interprets the Bankruptcy Code on one issue can sometimes help in understanding how the Court may approach other issues.

The Core Issue. In Marrama, the Supreme Court interpreted the following language in Section 706(a) of the Bankruptcy Code:

The debtor may convert a case under this chapter to a case under chapter 11, 12, or 13 of this title at any time, if the case has not be converted under section 1112, 1208, or 1307 of this title. Any waiver of the right to convert a case under this subsection is unenforceable.

Many courts had read this language to give a debtor an absolute right to convert a case from Chapter 7 to another bankruptcy chapter, even if the case might thereafter be reconverted back to Chapter 7. (Grounds for such reconversion could include previous bad faith or other misconduct of the debtor while in Chapter 7.)  The ability to convert can make a big difference to debtors because Chapter 7 cases always involve the appointment of a trustee to take possession of the debtor’s non-exempt assets for liquidation, unlike cases under Chapters 11, 12, and 13 in which the debtor can often retain property and pay creditors over time.  

The Court’s Reasoning. The Supreme Court decided that another provision, Section 706(d), limited this right to convert by requiring that the debtor must be able to be a debtor under the other chapter of choice. Section 706(d) provides: "Notwithstanding any other provision of this section, a case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter.” In Marrama, the Supreme Court held that a debtor who had acted in bad faith by concealing assets while in Chapter 7 could not qualify as a debtor under Chapter 13 because the Chapter 13 case would be dismissed "for cause" under Section 1307 of the Bankruptcy Code. The Supreme Court summarized its reasoning this way:

In practical effect, a ruling that an individual’s Chapter 13 case should be dismissed or converted to Chapter 7 because of prepetition bad-faith conduct, including fraudulent acts committed in an earlier Chapter 7 proceeding, is tantamount to a ruling that the individual does not qualify as a debtor under Chapter 13. That individual, in other words, is not a member of the class of ‘honest but unfortunate debtor[s]’ that the bankruptcy laws were enacted to protect. See Grogan v. Garner, 498 U. S., at 287. The text of §706(d) therefore provides adequate authority for the denial of his motion to convert.

A "Plain Language" Dissent. Interestingly, Justice Alito, joined by Chief Justice Roberts and Justices Scalia and Thomas, dissented. He found the majority’s interpretation of these sections to be strained and inconsistent with the plain meaning of the statutory language. As such, he believed that a debtor had an absolute right to convert out of Chapter 7 even if the case were subject to being reconverted after further proceedings.

Impact On Business Bankruptcy? It’s hard to see much direct impact on business bankruptcy cases from the decision, except perhaps in the very rare circumstance when a corporate debtor files a Chapter 7 but later seeks to convert the case to Chapter 11. However, the fact that four justices dissented on a "plain language" basis may be noteworthy. Many of the changes made by the recent Bankruptcy Abuse Prevention and Consumer Protection Act (also known as BAPCPA), including to business provisions, added language that appears to limit the exercise of discretion by bankruptcy judges. Perhaps the more interesting question, then, is whether the Marrama decision signals that the Supreme Court might consider loosening, if only slightly, the prevailing "plain language" interpretation of the Bankruptcy Code and allow judges to exercise more discretion than might otherwise be indicated by the language of the statute alone. Given that BAPCPA is less than 18 months old, we’ll probably have to wait a few years for an answer to that one.

Other Commentators On The Decision. Finally, when the Supreme Court issues a bankruptcy decision, a number of commentators write to share their perspectives. Scott Riddle of the Georgia Bankruptcy Law Blog was one of the first to report on the decision. Steve Jakubowski of The Bankruptcy Litigation Blog has an interesting post. In addition, John Pottow, a professor at the University of Michigan Law School, has an insightful post on the Credit Slips blog, as does Todd Zywicki, a professor at the George Mason University School of Law, over on The Volokh Conspiracy.

Business Bankruptcy Issues Recent Developments The Financially Troubled Company

The New Section 503(b)(9) Administrative Claim: The Latest On What Courts And Debtors Have Been Doing

A couple of months ago I posted on the new "20 day goods" administrative claim enacted as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"). BAPCPA, which took effect in October 2005, added Section 503(b)(9) to the Bankruptcy Code giving vendors an administrative priority claim for "the value of any goods received by the debtor within 20 days before" the date the bankruptcy petition was filed, as long as "the goods have been sold to the debtor in the ordinary course of such debtor’s business." 

In my earlier post, I posed a number of unresolved questions about this new section and predicted that courts would soon start to address those issues. Well, in the past couple of months we have in fact seen decisions answering at least a few of the questions raised by Section 503(b)(9).

The First Court Decisions. In late December 2006, bankruptcy courts in the District of Delaware and the Eastern District of Pennsylvania issued what appear to be the first two decisions on when and under what circumstances Section 503(b)(9) administrative claims must or should be paid. As explained below, in both decisions the bankruptcy court held that the administrative claimant was not necessarily entitled to payment prior to, in a Chapter 11 case, confirmation of a plan of reorganization.

  • In the first decision, issued December 21, 2006, Judge Kevin Gross of the U.S. Bankruptcy Court for the District of Delaware denied a creditor’s motion for payment of a Section 503(b)(9) administrative claim in the In re Global Home Products, LLC Chapter 11 bankruptcy case. The court held that the timing of payment of administrative claims is left to the discretion of the court. In so doing the court quoted with approval from an article that described Section 503(b)(9) as a "rule of priority, rather than payment." The court relied on a non-Section 503(b)(9) decision for the three factors to assess when considering when an administrative claim should be paid, chiefly, (a) the prejudice to the debtor, (b) hardship to the claimant, and (c) potential detriment to other creditors. The court applied those factors and denied the creditor’s request for immediate payment.
  • In the second decision, issued a week later on December 28, 2006, Judge Eric Frank of the U.S. Bankruptcy Court for the Eastern District of Pennsylvania denied a motion for immediate payment of Section 503(b)(9) claims filed by several creditors in the In re Bookbinders’ Restaurant, Inc. Chapter 11 bankruptcy case. Although the debtor agreed that the creditors were entitled to allowance of a "20 day goods" administrative claim, it opposed the immediate payment of those claims. The court held that the timing of payment was a matter of the court’s discretion but agreed to hold an evidentiary hearing to consider evidence to guide the exercise of that discretion.

A Few Early Take-Aways. In both of these decisions, the courts held that they have discretion to defer payment until the end of a Chapter 11 bankruptcy case, when a plan of reorganization is confirmed.

  • Creditors who can establish that failing to pay their Section 503(b)(9) claim would cause them hardship, but not prejudice the debtor or other creditors, may still be able to obtain immediate payment. As these cases show, however, creditors will find it challenging to meet that standard.
  • Interestingly, the Bookbinders court rejected what it called an "equal protection" argument by the creditors, who asserted that they should be paid immediately because vendors delivering goods to the debtor post-petition were being paid on their administrative claims. The court drew a distinction between the two claims, explaining that the creditors delivering goods post-petition were paid not under Section 503(b) but instead under Section 363(c)(1) of the Bankruptcy Code. That latter section allows a debtor in possession or trustee to enter into post-petition ordinary course of business transactions, and to pay for them, without court approval.
  • Finally, DIP financing orders can impact the timing of paying Section 503(b)(9) claims. In some cases the DIP budget may not include funds to pay these claims and in others the DIP order may expressly prohibit their payment. Section 503(b)(9) creditors may want to review proposed DIP financing motions carefully with this in mind.

What Debtors Have Been Doing. In an attempt to exert a degree of control over Section 503(b)(9) claims, some debtors have filed motions seeking to establish procedures to handle these claims, not unlike the procedures used in past cases for reclamation claims. In the Seattle case of In re Brown & Cole Stores, LLC, for example, the debtor filed a motion for an order establishing procedures for Section 503(b)(9) claims. The court granted the motion and entered a Section 503(b)(9) procedures order which, among other things:

  • Required creditors to file Section 503(b)(9) claims by a special bar date;
  • Required the debtor to file a report evaluating such claims 21 days after the special bar date;
  • Gave creditors 15 days thereafter to file a reply to the debtor’s position;
  • Made the debtor’s position binding in the event a creditor did not timely respond; and 
  • Reserved to the court the right to resolve any disputes. 

The order effectively reserved the issue of when valid Section 503(b)(9) claims would be paid but made the procedures the exclusive method for determining the validity and amount of such claims. I expect that other debtors will pursue similar procedures for handling these "20 day goods" claims.

Don’t Touch That Dial. These early decisions are the first in what should be many future rulings on the questions posed by Section 503(b)(9). I’ll continue to update you on how courts are interpreting this new administrative claim and, over time, we should begin to see more clarity on how debtors, vendors, and courts will address this new BAPCPA provision.

Business Bankruptcy Issues Recent Developments

Chapter 15: The Bankruptcy Code’s New Cross-Border Insolvency Rules

Chris Laughton, a UK insolvency practitioner and publisher of InsolvencyBlog.com, has a number of recent posts on the adoption in the UK of the Model Law on Cross-Border Insolvency (“Model Law”), a 1997 effort by the United Nations Commission on International Trade Law (“UNCITRAL”). That got me thinking that I should post something on the recent changes to the U.S. Bankruptcy Code on cross-border insolvencies.

Chapter What? 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 have been retained in Chapter 15.)

Where Did Chapter 15 Come From? The main purpose of enacting Chapter 15 was to incorporate the Model Law as part of the Bankruptcy Code. 11 U.S.C. § 1501(a). My partner Adam Rogoff, who has had significant experience with international insolvency matters, has prepared a very helpful chart comparing Chapter 15 and the Model Law’s provisions. Also, because Chapter 15 so closely follows the Model Law, the Legislative Guide to Enactment of the UNCITRAL Model Law on Cross-Border Insolvency, prepared by the Model Law’s authors, is one of the most helpful guides to understanding the meaning of Chapter 15’s provisions.

Given that Chapter 15 is such a creature of statute, I’ve included more citations to the Bankruptcy Code than usual in this post. They are all in the format 11 U.S.C. § ___, which refers to Title 11 of the United States Code (the title of U.S. law that sets out the Bankruptcy Code) and then a particular section number. 

Who Uses Chapter 15? 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). 

Learning A "Foreign" Language. Several important terms involving different types of foreign proceedings are key to understanding the scope of Chapter 15. 

  • 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). 

Getting Some Recognition:The Chapter 15 Process. Chapter 15’s basic procedure is straightforward. A case is commenced when a foreign representative 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). 

Formal recognition is the key step that triggers the benefits of Chapter 15. If recognition is granted as a foreign main proceeding, the debtor receives important protections and rights similar to those available to U.S.-based debtors. Chief among these are the automatic stay provisions of Section 1520(a) of the Code, which invoke the automatic stay of Section 362 with respect to the debtor and its property within the territorial jurisdiction of the United States. 11 U.S.C. § 1520(a). Other sections invoked by Section 1520 (including Sections 363, 549, and 552) apply to transfers of interests of the debtor in property within the territorial jurisdiction of the United States. 11 U.S.C. § 1520(a)(2). Unless the court orders otherwise, the foreign representative may also operate the debtor’s business consistent with Section 363 and 552. 11 U.S.C. § 1520(a)(3). 

A Matter Of Discretion. Section 1521 gives the court discretion to grant other appropriate relief at the request of the foreign representative, including in foreign nonmain proceedings which, unlike foreign main proceedings, do not invoke Section 1520’s automatic stay. 11 U.S.C. § 1521(a). Under Section 1521(a), the court may, among other things, stay actions or proceedings concerning the debtor’s assets, rights, obligations or liabilities, stay execution against the debtor’s assets, and suspend the right to transfer or dispose of assets of the debtor. 11 U.S.C. §§ 1521(a)(1), (2), and (3). However, Chapter 15 contains certain limitations on the ability of a court to grant the discretionary relief provided by Section 1521:

  • Relief is available only “where necessary to effectuate the purpose of this chapter and to protect the assets of the debtor or the interests of the creditors.” 11 U.S.C. § 1521(a). 
  • Congress made such relief expressly subject to the “standards, procedures, and limitations applicable to an injunction.” 11 U.S.C. § 1521(e). The court has discretion to make any relief granted subject “to conditions it considers appropriate, including the giving of security or the filing of a bond.” 11 U.S.C. § 1522(b).
  • Section 1507 requires the court, in determining whether to give additional assistance to a foreign representative, to consider “whether such additional assistance, consistent with the principles of comity, will reasonably assure” achievement of five specific objectives retained nearly verbatim from former Section 304(c). 
  • These objectives include “just treatment of all holders of claims,” “protection of claim holders in the United States against prejudice and inconvenience,” “prevention of preferential or fraudulent dispositions of property,” “distributions of proceeds” substantially according to the Bankruptcy Code, and, where appropriate, the opportunity for a fresh start for an individual. 

Over There: Protection For U.S. Creditors And Debtors. The Model Law has been adopted in a number of other countries, including Japan, Mexico, Poland, Romania, South Africa, and the UK. According to this recent post on the InsolvencyBlog.com, foreign creditors (including U.S. creditors) are fully recognized in UK insolvency proceedings. Representatives of U.S. based debtors may also obtain protection in countries that have adopted the Model Law. The European Union, which has not yet adopted the Model Law, has its own cross-border insolvency regulation that applies to all EU countries except Denmark.

Check Your Local Listings. Although Chapter 15 and the Model Law have been designed to help coordinate cross-border bankruptcy and insolvency proceedings, these restructurings and liquidations are complex and often require parties to navigate through multiple country-specific insolvency schemes. If you find yourself involved in a cross-border bankruptcy, whether as a debtor, creditor, or a member of a committee, it’s usually critical to get legal advice from U.S. and appropriate foreign insolvency counsel. 

Business Bankruptcy Issues Recent Developments

Copyrights And Bankruptcy Sales: The Importance Of Protecting Your Rights

I’ve posted in the past about bankruptcy asset sales and how parties with executory contracts need to keep track of bankruptcy cases to protect their rights. Steve Jakubowski of The Bankruptcy Litigation Blog has an entertaining and informative post about a recent Court of Appeals decision involving rappers, recording companies, copyrights, and bankruptcy that raises some similar issues.

It’s a cautionary tale about the importance of monitoring bankruptcy cases and acting to protect rights when copyrights are involved. (So you don’t get complacent, the same message applies for patents, trademarks, and other intellectual property, and especially when licenses are involved.) After describing the case briefly, I discuss some points to keep in mind when IP crosses the bankruptcy court’s door.

Setting The Stage. Some background on the facts of the case will help put things in perspective.

  • Act One: In 1989, Jeffrey Thompkins, a rap artist known as JT Money, entered into an exclusive recording agreement with the debtor (a recording company). In the agreement, Thompkins sold his sound recording copyrights in various songs in exchange for the debtor’s agreement to pay royalties on the records released. (A later agreement made the debtor a half owner in the musical composition copyrights as well.)
  • Act Two: Six years later, the debtor ended up in Chapter 11 bankruptcy. The copyrights were sold "free and clear" to another recording company for $800,000 as part of the debtor’s plan of reorganization, which the bankruptcy court confirmed. The recording agreement was ultimately rejected as an executory contract. Apparently, Tompkins neither objected to the sale nor defended his claim for damages after the recording agreement was rejected.

The Curtain Falls. Almost six years after the bankruptcy sale, Tompkins sued the purchaser of the copyrights in federal court, alleging copyright infringement and other claims. The district court granted the purchaser’s motion for summary judgment and the decision was affirmed on appeal. The Court of Appeals for the Eleventh Circuit held that even though the debtor had rejected the original recording agreement, under bankruptcy law that rejection acted only as a breach and not as a rescission of the contract. Quoting from earlier decisions, the Court of Appeals commented that rejection does not "vaporize" a debtor’s rights under a rejected contract. Here the debtor retained ownership of the copyrights transferred under the recording agreement even though it breached the obligation to pay royalties. Because the purchaser was the actual owner of the copyrights, the infringement claim failed.

Encore: Lessons For The Audience. What can intellectual property owners and debtors learn from this decision?

  • A transfer of IP under an executory contract will not be rescinded if the buyer later files bankruptcy and rejects the agreement.
  • An IP owner looking for more control over its IP should consider granting a license instead of making an outright sale subject only to a royalty obligation. In some industries this may not be a realistic alternative, but when possible it can give IP owners more control. 
  • In many jurisdictions, IP owners who have granted only non-exclusive licenses prohibiting assignment will have the equivalent of a veto right in bankruptcy over proposed assignments of the license. This is generally true for copyrights, patents, and possibly trademarks, and can have a big impact on a debtor’s ability to transfer license rights.
  • When a licensee or other debtor with rights related to IP files bankruptcy, it’s critical for IP owners to monitor the bankruptcy case and be prepared to take action to defend their rights. Among the issues that can come up: asset sales involving a sale of the IP or an assignment of license rights, breaches of license terms, and infringement issues.
  • Likewise, debtors and creditors committees need to understand what IP rights the debtor has, what consents may be required to assign or transfer those rights, and how the rights of third party licensors and other IP owners may impact asset sales and reorganization prospects.

Conclusion. The intersection between intellectual property and bankruptcy law can be complex. Whether you are an IP owner, a debtor, or a committee, getting good legal advice before and after a bankruptcy is filed can be critical in protecting your rights.

Business Bankruptcy Issues Recent Developments

Delaware Bankruptcy Court Denies Reclamation Claimant’s TRO Request To Stop Sale Of Goods

In a recent post, I discussed how Section 546(c) of the Bankruptcy Code, as revised by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("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 senior lien in the same goods.

The Advanced Marketing Services case. Section 546(c)’s expanded reclamation rights, and how they may be impacted by the "prior rights" of a secured creditor, recently played out in the Chapter 11 bankruptcy case of In re Advanced Marketing Services, Inc. pending in the United States Bankruptcy Court in Delaware.

Simon & Schuster, Inc., a reclamation claimant, filed a complaint against the debtor, Advanced Marketing Services, Inc. ("AMS"), seeking to reclaim more than $5 million worth of goods that the debtor allegedly received in the 45 days prior to the bankruptcy filing. (You can access the pleadings from the Simon & Schuster litigation by clicking on the appropriate links in this post.)

  • In an effort to gain control over the goods at issue, Simon & Schuster filed an application for a temporary restraining order (known as a "TRO") seeking a court order to prevent AMS from selling the goods. 
  • The debtor opposed the TRO, challenging whether Simon & Schuster had the right to reclaim the goods.
  • The debtor’s secured creditor, Wells Fargo Foothill, Inc., also filed an opposition to the TRO, arguing that the reclamation claim was subject to its prior rights as a prepetition secured creditor and as a debtor in possession ("DIP") lender. In this case, the DIP loan has been structured as a "creeping roll up" in which prepetition obligations are to be satisfied by the use of cash collateral and the DIP lender in turn receives a postpetition lien as that cash collateral is used.
  • Simon & Schuster filed a reply brief responding to the opposition papers filed by the debtor and the secured creditor.

The Court’s Decision. In a decision issued by the Bankruptcy Court yesterday, Judge Sontchi denied Simon & Schuster’s application for a TRO without prejudice, holding that Section 546(c) made Simon & Schuster’s reclamation rights subject to the prior rights of the secured creditors. (The Bankruptcy Court also noted that it would have reached the same result under pre-BAPCPA bankruptcy and UCC law.)

  • The Bankruptcy Court held that the secured creditors had superior prepetition and postpetition liens in the goods Simon & Schuster sought to reclaim and that Simon & Schuster therefore could not establish that it was likely to prevail on the merits of its reclamation claim.
  • The Bankruptcy Court also rejected any attempt to require "marshaling" by the secured creditor, which if ordered could have required the secured creditor to satisfy its claim first from collateral other than the goods that Simon & Schuster sought to reclaim.

Stay Tuned. As one of the first decisions on this reclamation issue under BAPCPA, the Advanced Marketing Services decision is an important one. However, it’s not the last word on how the respective rights of reclaiming vendors and secured creditors will be decided in Chapter 11 cases. Reclamation issues are often fact dependent and results may vary in different cases. Also, vendors unable to prevail on a reclamation claim may still have a "20 day goods" administrative claim, and this fact may influence how debtors treat vendors in future cases.