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Business Bankruptcy Issues Recent Developments

Going Up: Bankruptcy Dollar Amounts Will Increase On April 1, 2013

It hasn’t gotten much publicity yet, but certain dollar amounts in the Bankruptcy Code will be increased for new cases filed on or after April 1, 2013. Follow this link for a chart listing all of the changes on this Federal Register page, which printed this month’s official notice from the Judicial Conference of the United States.

Among the most meaningful increases for Chapter 11 and other business bankruptcy cases:

  • The total amount of claims required to file an involuntary petition rises to $15,325 from $14,425;
  • The employee compensation and benefit plan contribution priorities under Sections 507(a)(4) and 507(a)(5) both increase to $12,475 from $11,725;
  • The consumer deposit priority under Section 507(a)(7) rises to $2,775 from $2,600;
  • The dollar amount in the bankruptcy venue provision, 28 U.S.C. Section 1409(b), which requires that actions to recover for non-consumer, non-insider debt be brought against defendants in the district in which they reside, has increased to $12,475 from $11,725;
  • The minimum amount required to bring a preference claim against a defendant in a non-consumer debtor case, specified in Section 547(c)(9), rises from $6,225 from $5,475; and
  • The total debt amount in the definition of small business debtor in Section 101(51D) will rise to $2,490,925.

Other adjustments will affect consumers more than business debtors. For example, the debt limit for an individual to be able to qualify to file a Chapter 13 bankruptcy case will rise to $1,149,525 of secured debt, and certain exemption amounts will also rise.

Although the changes aren’t substantial, be sure to keep them in mind when assessing cases filed after April 1st.

Business Bankruptcy Issues Recent Developments The Financially Troubled Company

Spring 2011 Edition Of Bankruptcy Resource Now Available

The Spring 2011 edition of the Absolute Priority newsletter, published by the Cooley LLP Bankruptcy & Restructuring group, of which I am a member, has just been released. The newsletter gives updates on current developments and trends in the bankruptcy and workout area. Follow the links in this sentence to access a copy of the newsletter. You can also subscribe to the blog to learn when future editions of the Absolute Priority newsletter are published, as well as to get updates on other bankruptcy and insolvency topics.

The latest edition of Absolute Priority covers a range of cutting edge topics, including:

  • Recent case law on third-party releases in bankruptcy plans;
  • Treatment of make-whole and no-call provisions in bankruptcy;
  • Breach of fiduciary duty claims against managers of insolvent Delaware LLCs; and
  • Ordinary course of business defense to preferences.

This edition also reports on some of our recent representations, including the successful Chapter 11 reorganization of our client, retailer Crabtree & Evelyn, Ltd., and our work for official committees of unsecured creditors in Chapter 11 bankruptcy cases involving major retailers and others. Recent committee cases include Blockbuster, Orchard Brands, Ultimate Electronics, Claim Jumper Restaurants, OTC Holdings, Urban Brands, Mervyn’s Holdings, Sierra Snowboard, Trade Secrets, Mt. Diablo YMCA, and Pacific Metro, among others.

I hope you find the latest edition of Absolute Priority to be of interest.

Business Bankruptcy Issues Recent Developments

Recent Decision Holds That Section 503(b)(9) “20 Day” Claims Can Be Used As Part Of New Value Preference Defense

Earlier this year, the U.S. Bankruptcy Court for the Middle District of Tennessee issued a decision holding that creditors sued for preferences can assert a new value defense based on the goods provided to a debtor in the 20 days before the bankruptcy case was filed. The debtor had challenged the effort to use those 20 day goods as new value because they are entitled to administrative claim priority under Section 503(b)(9) of the Bankruptcy Code. 

The law in this area continues to develop and trade vendors and suppliers of goods will find this update of particular interest.

Business Bankruptcy Issues Recent Developments

Spring 2009 Edition Of Bankruptcy Resource Is Now Available

The Spring 2009 edition of the Absolute Priority newsletter, published by the Cooley Godward Kronish LLP Bankruptcy & Restructuring group, of which I am a member, has just been released. The newsletter gives updates on current developments and trends in the bankruptcy and workout area. Follow the links in this sentence to access a copy of the newsletter or to register to receive future editions. You can also subscribe to the blog to learn when future editions of the Absolute Priority newsletter are published, as well as to get updates on other bankruptcy topics.

The latest edition of Absolute Priority covers a range of cutting edge topics, including:

  • Claim issues involving the Madoff SIPA proceeding;
  • How new Bankruptcy Code provisions involving swap agreements and swap participants are being interpreted;
  • The importance of the mutuality requirement in setoffs;
  • Post-petition rent and Section 503(b)(9) "20 day goods" claims; and
  • The use of a trademark after a bankruptcy petition is filed.

This edition also reports on some of our recent representations of official committees of unsecured creditors in Chapter 11 bankruptcy cases involving major retailers. These include Mervyn’s, Boscov’s, Gottschalk’s, Lenox Sales, Goody’s, KB Toys, BTWW Retail, and Innovative Luggage, among others. In addition, a note from my colleague, Jeffrey Cohen, the editor of Absolute Priority, discusses the current economic climate and the impact it continues to have on how debtors and creditors have been approaching bankruptcies and restructurings.

I hope you find this latest edition of Absolute Priority to be a helpful resource.

Business Bankruptcy Issues The Financially Troubled Company

Assignments For The Benefit Of Creditors: Simple As ABC?

Companies in financial trouble are often forced to liquidate their assets to pay creditors. While a Chapter 11 bankruptcy sometimes makes the most sense, other times a Chapter 7 bankruptcy is required, and in still other situations a corporate dissolution may be best. This post examines another of the options, the assignment for the benefit of creditors, commonly known as an "ABC."

A Few Caveats. It’s important to remember that determining which path an insolvent company should take depends on the specific facts and circumstances involved. As in many areas of the law, one size most definitely does not fit all for financially troubled companies. With those caveats in mind, let’s consider one scenario sometimes seen when a venture-backed or other investor-funded company runs out of money.

One Scenario. After a number of rounds of investment, the investors of a privately held corporation have decided not to put in more money to fund the company’s operations. The company will be out of cash within a few months and borrowing from the company’s lender is no longer an option. The accounts payable list is growing (and aging) and some creditors have started to demand payment. A sale of the business may be possible, however, and a term sheet from a potential buyer is anticipated soon. The company’s real property lease will expire in nine months, but it’s possible that a buyer might want to take over the lease.

  • A Chapter 11 bankruptcy filing is problematic because there is insufficient cash to fund operations going forward, no significant revenues are being generated, and debtor in possession financing seems highly unlikely unless the buyer itself would make a loan. 
  • The board prefers to avoid a Chapter 7 bankruptcy because it’s concerned that a bankruptcy trustee, unfamiliar with the company’s technology, would not be able to generate the best recovery for creditors.

The ABC Option. In many states, another option that may be available to companies in financial trouble is an assignment for the benefit of creditors (or "general assignment for the benefit of creditors" as it is sometimes called). The ABC is an insolvency proceeding governed by state law rather than federal bankruptcy law.

California ABCs. In California, where ABCs have been done for years, the primary governing law is found in California Code of Civil Procedure sections 493.010 to 493.060 and sections 1800 to 1802, among other provisions of California law. California Code of Civil Procedure section 1802 sets forth, in remarkably brief terms, the main procedural requirements for a company (or individual) making, and an assignee accepting, a general assignment for the benefit of creditors:

1802.  (a) In any general assignment for the benefit of creditors, as defined in Section 493.010, the assignee shall, within 30 days after the assignment has been accepted in writing, give written notice of the assignment to the assignor’s creditors, equityholders, and other parties in interest as set forth on the list provided by the assignor pursuant to subdivision (c).
   (b) In the notice given pursuant to subdivision (a), the assignee shall establish a date by which creditors must file their claims to be able to share in the distribution of proceeds of the liquidation of the assignor’s assets.  That date shall be not less than 150 days and not greater than 180 days after the date of the first giving of the written notice to creditors and parties in interest.
   (c) The assignor shall provide to the assignee at the time of the making of the assignment a list of creditors, equityholders, and other parties in interest, signed under penalty of  perjury, which shall include the names, addresses, cities, states, and ZIP Codes for each person together with the amount of that person’s anticipated claim in the assignment proceedings.

In California, the company and the assignee enter into a formal "Assignment Agreement." The company must also provide the assignee with a list of creditors, equityholders, and other interested parties (names, addresses, and claim amounts). The assignee is required to give notice to creditors of the assignment, setting a bar date for filing claims with the assignee that is between five to six months later.

ABCs In Other States. Many other states have ABC statutes although in practice they have been used to varying degrees. For example, ABCs have been more common in California than in states on the East Coast, but important exceptions exist. Delaware corporations can generally avail themselves of Delaware’s voluntary assignment statutes, and its procedures have both similarities and important differences from the approach taken in California. Scott Riddle of the Georgia Bankruptcy Law Blog has an interesting post discussing ABC’s under Georgia law. Florida is another state in which ABCs are done under specific statutory procedures. For an excellent book that has information on how ABCs are conducted in various states, see Geoffrey Berman’s General Assignments for the Benefit of Creditors: The ABCs of ABCs, published by the American Bankruptcy Institute.

Important Features Of ABCs. A full analysis of how ABCs function in a particular state and how one might affect a specific company requires legal advice from insolvency counsel. The following highlights some (but by no means all) of the key features of ABCs:

  • Court Filing Issue. In California, making an ABC does not require a public court filing. Some other states, however, do require a court filing to initiate or complete an ABC.
  • Select The Assignee. Unlike a Chapter 7 bankruptcy trustee, who is randomly appointed from those on an approved panel, a corporation making an assignment is generally able to choose the assignee.
  • Shareholder Approval. Most corporations require both board and shareholder approval for an ABC because it involves the transfer to the assignee of substantially all of the corporation’s assets. This makes ABCs impractical for most publicly held corporations.
  • Liquidator As Fiduciary. The assignee is a fiduciary to the creditors and is typically a professional liquidator.
  • Assignee Fees. The fees charged by assignees often involve an upfront payment and a percentage based on the assets liquidated.
  • No Automatic Stay. In many states, including California, an ABC does not give rise to an automatic stay like bankruptcy, although an assignee can often block judgment creditors from attaching assets.
  • Event Of Default. The making of a general assignment for the benefit of creditors is typically a default under most contracts. As a result, contracts may be terminated upon the assignment under an ipso facto clause.
  • Proof Of Claim. For creditors, an ABC process generally involves the submission to the assignee of a proof of claim by a stated deadline or bar date, similar to bankruptcy. (Click on the link for an example of an ABC proof of claim form.)
  • Employee Priority. Employee and other claim priorities are governed by state law and may involve different amounts than apply under the Bankruptcy Code. In California, for example, the employee wage and salary priority is $4,300, not the $10,950 amount currently in force under the Bankruptcy Code.
  • 20 Day Goods. Generally, ABC statutes do not have a provision similar to that under Bankruptcy Code Section 503(b)(9), which gives an administrative claim priority to vendors who sold goods in the ordinary course of business to a debtor during the 20 days before a bankruptcy filing. As a result, these vendors may recover less in an ABC than in a bankruptcy case, subject to assertion of their reclamation rights.
  • Landlord Claim. Unlike bankruptcy, there generally is no cap imposed on a landlord’s claim for breach of a real property lease in an ABC.
  • Sale Of Assets. In many states, including California, sales by the assignee of the company’s assets are completed as a private transaction without approval of a court. However, unlike a bankruptcy Section 363 sale, there is usually no ability to sell assets "free and clear" of liens and security interests without the consent or full payoff of lienholders. Likewise, leases or executory contracts cannot be assigned without required consents from the other contracting party.
  • Avoidance Actions. Most states allow assignees to pursue preferences and fraudulent transfers. However, the U.S. Court of Appeals for the Ninth Circuit has held that the Bankruptcy Code pre-empts California’s preference statute, California Code of Civil Procedure section 1800. Nevertheless, to date the California state courts have refused to follow the Ninth Circuit’s decision and still permit assignees to sue for preferences in California state court. In February 2008, a Delaware state court followed the California state court decisions, refusing either to follow the Ninth Circuit position or to hold that the California preference statute was pre-empted by the Bankruptcy Code. The Delaware court was required to apply California’s ABC preference statute because the avoidance action arose out of an earlier California ABC.

The Scenario Revisited. With this overview in mind, let’s return to our company in distress.

  • The prospect of a term sheet from a potential buyer may influence whether our hypothetical company should choose an ABC or another approach. Some buyers will refuse to purchase assets outside of a Chapter 11 bankruptcy or a Chapter 7 case. Others are comfortable with the ABC process and believe it provides an added level of protection from fraudulent transfer claims compared to purchasing the assets directly from the insolvent company. Depending on the value to be generated by a sale, these considerations may lead the company to select one approach over the other available options.
  • In states like California where no court approval is required for a sale, the ABC can also mean a much faster closing — often within a day or two of the ABC itself provided that the assignee has had time to perform due diligence on the sale and any alternatives — instead of the more typical 30-60 days required for bankruptcy court approval of a Section 363 sale. Given the speed at which they can be done, in the right situation an ABC can permit a "going concern" sale to be achieved.
  • Secured creditors with liens against the assets to be sold will either need to be paid off through the sale or will have to consent to release their liens; forced "free and clear" sales generally are not possible in an ABC.
  • If the buyer decides to take the real property lease, the landlord will need to consent to the lease assignment. Unlike bankruptcy, the ABC process generally cannot force a landlord or other third party to accept assignment of a lease or executory contract.
  • If the buyer decides not to take the lease, or no sale occurs, the fact that only nine months remains on the lease means that this company would not benefit from bankruptcy’s cap on landlord claims. If the company’s lease had years remaining, and if the landlord were unwilling to agree to a lease termination approximating the result under bankruptcy’s landlord claim cap, the company would need to consider whether a bankruptcy filing was necessary to avoid substantial dilution to other unsecured creditor claims that a large, uncapped landlord claim would produce in an ABC.
  • If the potential buyer walks away, the assignee would be responsible for determining whether a sale of all or a part of the assets was still possible. In any event, assets would be liquidated by the assignee to the extent feasible and any proceeds would be distributed to creditors in order of their priority through the ABC’s claims process.
  • While other options are available and should be explored, an ABC may make sense for this company depending upon the buyer’s views, the value to creditors and other constituencies that a sale would produce, and a clear-eyed assessment of alternative insolvency methods. 

Conclusion. When weighing all of the relevant issues, an insolvent company’s management and board would be well-served to seek the advice of counsel and other insolvency professionals as early as possible in the process. The old song may say that ABC is as "easy as 1-2-3," but assessing whether an assignment for the benefit of creditors is best for an insolvent company involves the analysis of a myriad of complex factors.

Business Bankruptcy Issues

The Terrible Twos? A Look At BAPCPA’s Impact On Business Bankruptcy Cases At Its Second Anniversary

Tomorrow, October 17, 2007, marks the second anniversary of the effective date of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, known as BAPCPA.  BAPCPA was enacted primarily to make sweeping changes to the consumer provisions of the Bankruptcy Code. However, BAPCPA also made significant revisions in the business bankruptcy arena.  When it was passed, bankruptcy lawyers, creditors, and potential debtors had many questions about how these changes would play out as new cases made their way through the system. Two years out, we now have answers to some of those questions.

In this post I’ll look at a few of BAPCPA’s more substantial revisions and how courts have addressed them so far. These include new rules governing real estate leases, reclamation, the "20 day goods" administrative claim, key employee retention plans, cross-border bankruptcy cases, and an important preference defense. As we walk down memory lane, I’ll also point you to earlier posts where you can find more details on these issues.

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

  • Before BAPCPA, debtors initially had only 60 days to assume or reject leases but there was no statutory limit on extensions of that period. Cumulative extensions of a year or more, over a landlord’s objection, were not uncommon under the pre-BAPCPA version of the Bankruptcy Code. That is no longer possible under BAPCPA.
  • Below market leases can represent a significant asset, particularly for retailers with many store leases, and BAPCPA has forced these debtors to move very quickly to assume and assign leases or to sell designation rights to make the most of the 210 day maximum period. In a number of cases, this 210 day limit has depressed the value of the debtor’s leases and the recovery for its creditors.
  • For more on real estate leases, you may want to read "Commercial Real Estate Leases: How Are They Treated In Bankruptcy?" previously posted on this blog.

Reclamation. When a debtor becomes insolvent or files bankruptcy, some vendors may be able to take advantage of a special, although limited, right to get back or "reclaim" certain of the goods. This reclamation right is part of both the Uniform Commercial Code and the Bankruptcy Code. BAPCPA made some changes in the reclamation area and post-BAPCPA cases have put some meat on the bones of those changes. A new, 45-day bankruptcy reclamation right was added to Section 546(c) of the Bankruptcy Code, expanding the Uniform Commercial Code’s 10-day rule. Under BAPCPA, the goods must have been sold in the "ordinary course" of the vendor’s business and the debtor must have received the goods while insolvent. The reclamation demand must be in writing and made within 45 days of the receipt of the goods by the customer (now the debtor in bankruptcy).  If the 45-day period expires after the bankruptcy case is filed, the vendor must make the reclamation demand within 20 days after the bankruptcy filing.

Two decisions from earlier this year have helped clarify the impact, and highlight the limitations, of BAPCPA’s reclamation changes.

  • In January 2007, Judge Christopher S. Sontchi of the U.S. Bankruptcy Court for the District of Delaware refused to issue a temporary restraining order in favor of a reclamation claimant in the Advanced Marketing Services case who sought to prevent the sale of goods it was trying to reclaim. The Court cited the superior rights of the secured creditor, which had a lien on the goods. A discussion of the case and a copy of the Court’s decision is available at this earlier post.
  • Then, in April 2007, Judge Burton R. Lifland of the U.S. Bankruptcy Court for the Southern District of New York applied the "prior lien defense" in favor of a secured creditor by valuing all reclamation claims in the Dana Corporation case at zero. You can find a discussion of that case and a copy of the decision at this previous post.

The "20 Day Goods" Administrative Claim. Although the post-BAPCPA decisions have not been favorable to vendors in the reclamation area, recent developments have underscored the value of the new Section 503(b)(9) administrative claim. That new provision, added by BAPCPA, gives vendors an administrative priority claim for "the value of any goods received by the debtor within 20 days before" the date a bankruptcy petition was filed "in which the goods have been sold to the debtor in the ordinary course of such debtor’s business."  For an overview of the new provision, you may find the post entitled "20 Day Goods: New Administrative Claim For Goods Sold Just Before Bankruptcy," of interest.

Key Employee Retention Plans. One of BAPCPA’s most notable changes was the significant restrictions imposed on key employee retention plans, known as KERPs. Prior to BAPCPA, KERPs were a very popular way of making sure that a company could retain its most important officers and employees to guide it through bankruptcy. Citing perceived abuses, however, Congress added language in BAPCPA that requires debtors to satisfy nearly impossible standards before courts would be permitted to approve payment of retention bonuses (or severance payments) as administrative claims to officers and other insiders of a bankrupt company. In short, a debtor would have to show that the individual was essential the the survival of the business and that he or she had a bona fide job offer from another business at the same or greater rate of compensation.

Debtors looking to compensate key officers have moved away from retention plans entirely and instead have turned to incentive plans. 

  • Several courts have approved incentive plans covering insiders but have applied certain factors to judge the reasonableness of the plan, including an assessment of the relationship between the plan and the results to be obtained, the cost of the plan, and whether the plan’s overall scope is fair and reasonable.
  • In May 2007, the Delaware Bankruptcy Court even approved a downward adjustment to an incentive plan’s targets, permitting a bonus to be paid to insiders, when the original plan’s targets turned out to be unrealistic. 
  • For more on this topic, including copies of three significant decisions in the Dana Corporation, Global Home Products, and Nellson Nutraceuticals cases, follow the link to this earlier post on key employee incentive plans.

Chapter 15 On Cross-Border Bankruptcies. BAPCPA added a new chapter to the Bankruptcy Code to adopt an internationally drafted Model Law on Cross-Border Insolvency.  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. Follow the link in this sentence for a detailed overview of Chapter 15.

  • In a recent case involving two Bear Stearns hedge funds, the Bankruptcy Court in the Southern District of New York refused to recognize proceedings pending in the Cayman Islands as either a foreign main or foreign nonmain proceeding, denying those entities Chapter 15 protection in the United States.
  • You can find the details on this case (and a copy of the original and amended decisions) here and here.

Preferences. Before it took effect, one of BAPCPA’s most talked about changes was a revision to the "ordinary course of business" defense to preference claims. BAPCPA dropped the requirement that a preference defendant establish that a transfer was both (i) made in the ordinary course of business or financial affairs between the debtor and the defendant and (ii) made according to ordinary business terms.

  • BAPCPA’s main change was to replace the "and" with an "or", meaning that a preference defendant now has to establish only one of the two prongs (instead of both) to prevail on the defense. When it was enacted, many bankruptcy lawyers believed this change would favor preference defendants. 
  • In something of a surprise, however, the first case interpreting the revised statute applied a brand new standard to the "ordinary business terms" provision. Unlike the prior analysis of that prong, the new standard examined the question from the perspective of both the creditor (as had been done pre-BAPCPA) and the debtor (the new BAPCPA twist). As a result, in that decision the preference defendant lost. For more on the decision, in the In re National Gas Distributors, LLC case, check out this post on David Rosendorf’s BAPCPA Blog.
  • There have been surprisingly few cases interpreting this section, so it remains to be seen whether other courts will follow the National Gas Distributors interpretation.

Another Great BAPCPA Resource. In addition to the BAPCPA Blog, which has posts on many decisions from BAPCPA’s first year, don’t miss Steve Jakubowski’s Bankruptcy Litigation Blog, in particular his BAPCPA and BAPCPA Outline topics. Steve has posted on a range of BAPCPA issues, including major consumer decisions and many business bankruptcy decisions.

Acting Like A Two Year Old? As we begin the third year under BAPCPA, the law is beginning to take early steps toward greater clarity in some areas but much remains to be decided. In particular, few appellate decisions have been issued on BAPCPA’s key changes, giving us little guidance on how the Courts of Appeals will interpret the new law.  As always, stay tuned for more developments and feel free to subscribe to the blog by email or by RSS to your feedreader.

Business Bankruptcy Issues Recent Developments The Financially Troubled Company

Ordinary Course Preference Case Takes Extraordinary Turn: Ninth Circuit Strikes Down Local Bankruptcy Rule On Jury Trials

Preference lawsuits are filed all the time in bankruptcy cases and the ordinary course of business defense is frequently asserted. Still, it’s the rare case that ends up with a federal court of appeals decision addressing jury trial rights and invalidating a bankruptcy court’s local rule. This post is about just such a case.

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.

Jury Trials In Bankruptcy Cases? Preference defendants who do not file proofs of claim in the main bankruptcy case have the option to demand a trial by jury in the preference lawsuit. This is a right protected by the Seventh Amendment to the Constitution. The parties in the lawsuit can consent to having the bankruptcy court conduct the jury trial but this doesn’t happen very often. Why would a preference defendant make a jury demand? Here are three common reasons:

  • The defendant believes a jury would be more inclined to find in its favor than a bankruptcy judge;
  • The defendant wants the case moved to federal district court from the bankruptcy court, which some defendants perceive as more debtor-friendly; and
  • Jury trials are more expensive and complex, a fact the preference defendant may hope will translate into settlement leverage.

The HealthCentral.com Case. In a recent case, Sigma Micro Corporation, a company sued for an alleged preference by debtor HealthCentral.com, made just such a jury trial demand. It then filed a motion for certification before the bankruptcy court seeking to have its case moved to the district court, in accordance with Local Rule 9015-2(b) of the United States Bankruptcy Court for the Northern District of California. That Local Rule, entitled "Certification to District Court," provides:

If the Bankruptcy Judge determines that [a] demand was timely made and the party has a right to a jury trial, and if all parties have not filed written consent to a jury trial before the Bankruptcy Judge, the Bankruptcy Judge shall certify to the District Court that the proceeding is to be tried by a jury and that the parties have not consented to a jury trial in the Bankruptcy Court. Upon such certification, [the jurisdictional] reference of the proceeding shall be automatically withdrawn, and the proceeding assigned to a Judge of the District . . . .

The Bankruptcy Court held that Sigma had a right to a jury trial but then stayed its order to retain jurisdiction for pre-trial matters. It later granted the debtor’s motion for summary judgment in the preference case, finding no genuine issue of material fact and rejecting Sigma’s ordinary course of business defense. On appeal, Sigma argued that the Bankruptcy Court did not have jurisdiction to enter summary judgment because it should have transferred the case to the District Court upon finding that Sigma was entitled to a jury trial. It also argued that it had raised genuine issues of material fact on its ordinary course of business defense, precluding summary judgment.

The Ninth Circuit’s Decision. On September 21, 2007, the Ninth Circuit issued its opinion in the case (available here).  In addressing the jurisdiction question, the Ninth Circuit confronted "an issue of first impression in this circuit, that is, the validity of Local Rule 9015-2(b)." After reviewing the right of courts to promulgate local rules, it came to the core of the issue:

Considering these rules we hold Local Rule 9015-2(b) to be invalid as it establishes a procedure for withdrawing the district court’s jurisdictional reference inconsistent with the Acts of  Congress and Federal Rules of Bankruptcy Procedure. Cf. Coffey v. Marina Management Servs. (In re Kool, Mann, Coffee), 23 F.3d 66, 67-69 (3rd Cir. 1994) (finding local rule invalid because of inconsistency with Bankruptcy Code); In re Morrissey, 717 F.2d 100, 104-05 (3rd Cir. 1983) (same).

The Ninth Circuit noted that 28 U.S.C. § 157(d) provides that a "district court" may withdraw the reference of all or a part of a case or proceeding and that Federal Rule of Bankruptcy Procedure 5011(a) expressly states that a "motion for withdrawal of a case or proceeding shall be heard by a district judge." Putting these two provisions together, the Court of Appeals held:

After careful review we find the procedure established by Local Rule 9105-2(b) cannot be squared with the procedure established by 28 U.S.C. § 157(d), an “Act of Congress,” and Rule 5011(a), a “Federal Rule of Bankruptcy Procedure.” Fed. R. Bankr. Proc. 9029. At least two inconsistencies bear mentioning. First, Local Rule 9015-2(b) allows for the bankruptcy court to “withdraw[ ]” the jurisdictional reference, whereas 28 U.S.C. § 157(d) and Rule 5011(a) make it explicit that only a district court may “withdraw” the jurisdictional reference. See FTC v. First Alliance Mortg. Co. (In re First Alliance Mortg. Co.), 282 B.R. 894, 901 (C.D. Cal. 2001) (holding that “a motion [to withdrawal] is heard by the district court”) (emphasis added). Second, Local Rule 9015-2(b) permits a party to obtain a withdrawal of the reference upon a “Motion for Certification,” while 28 U.S.C. § 157(d) and Rule 5011(a) make it clear that a party may only obtain a withdrawal of the reference upon a “Motion for Withdrawal.” See Hawaiian Airlines, Inc. v. Mesa Air Group, Inc., 355 B.R. 214, 218 (D. Hi. 2006) (holding that “a litigant who believes that a certain [action] or portion of a [action] pending in the bankruptcy court should be litigated in the district court may make a motion to withdraw the reference”) (emphasis added).

Having invalidated the Local Rule, the Ninth Circuit found no error in the Bankruptcy Court’s decision not to adhere to it or to withdraw the reference. The Court of Appeal then considered whether the Seventh Amendment jury trial right itself required immediate transfer to the District Court, even for pre-trial proceedings. The Ninth Circuit agreed with courts outside the circuit that, it stated, had universally agreed that a jury trial right "does not mean that the bankruptcy court must instantly give up jurisdiction and that the case must be transferred to the district court."

Concluding that the Bankruptcy Court properly retained the case for pre-trial matters, the Ninth Circuit did ultimately reverse its grant of summary judgment. It found that Sigma had raised genuine issues of material fact on its ordinary course of business defense under the version of Section 547(c)(2) of the Bankruptcy Code in force prior to the amendments made by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

What About Local Rules In Other Courts? It appears that the Northern District of California’s local bankruptcy rule on certification of a jury trial right and transfer to the District Court is unusual. Some bankruptcy courts, including the District of Delaware and the Southern District of New York, have no specific rule addressing withdrawal of the reference based on a jury demand. Others require a prompt motion for withdrawal of the reference to be filed with the District Court, as provided in Central District of California Local Bankruptcy Rule 9015-2(g). 

Conclusion. Although it appears that the decision’s direct impact is limited to the Northern District of California and its jury demand procedures, this case proves that even well-established local rules will be struck down if inconsistent with governing statutes. That’s a pretty extraordinary outcome for an ordinary course of business preference case.