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Business Bankruptcy Issues Recent Developments

Amendments To The Federal Rules Of Bankruptcy Procedure Take Effect December 1, 2017

Just about every year amendments are made to the rules that govern how bankruptcy cases are managed — the Federal Rules of Bankruptcy Procedure. The amendments address issues identified by an Advisory Committee made up of federal judges, bankruptcy attorneys, and others. As the photo above reminds us, the rule amendments are ultimately adopted by the U.S. Supreme Court (and technically subject to Congressional disapproval).

Key Rule Amendments For Business Bankruptcy Cases. This year, the majority of rule amendments involve consumer cases. For example, one notable change should lead to the creation of a national form Chapter 13 plan whose use will be required — unless a local form Chapter 13 plan has been adopted in its place.

Since In The Red® is focused on business bankruptcy developments, this post will highlight only those rule amendments impacting business cases. Be sure to read all of the amendments (see link below) and, if relevant to you, review the changes affecting consumer bankruptcy cases, which are not discussed below.

With that caveat, these changes are of particular note for business bankruptcy cases:

  • Rule 1001 has been amended to note that the Federal Rules of Bankruptcy Procedures are not just to be construed but also “administered” and “employed by the court and the parties” to secure the just, speedy, and inexpensive determination of every case and proceeding. This is consistent with revisions previously made to the Federal Rules of Civil Procedure.
  • Rule 3002 has been amended in several important ways.
    • First, a secured creditor is now required to file a proof of claim to have an allowed secured claim. Failing to do so will not alone lead to the lien securing the claim being deemed void.
    • Second, the deadline for filing a proof of claim in a voluntary Chapter 7, Chapter 12, or Chapter 13 case is not later than 70 days after entry of the order for relief (or the date of the order of conversion to a Chapter 12 or Chapter 13 case). In an involuntary Chapter 7 case, the proof of claim deadline is not later than 90 days after the entry of the order for relief. The old 90 days after the “first date set for the meeting of creditors” language has been jettisoned. These amendments leave unchanged how deadlines for filing proofs of claim in Chapter 11 cases under Rule 3003(c)(3) are established.
    • Third, Rule 3002 contains other provisions in recognition that the claim deadline will now be earlier in Chapter 7, 12, and 13 cases. The court, on motion filed before or after the deadline expires, may extend the time for filing a proof of claim for not more than 60 days following the date a motion seeking additional time is granted in certain circumstances. Those cover situations where (1) a debtor fails timely to file the required Rule 1007(a) list of creditor names and addresses or (2) the notice was insufficient to provide the creditor with a reasonable time to file a proof of claim but only if the notice was mailed to a foreign address.
  • Rule 3007 has been revised to clarify that Rule 7004’s specific service requirements do not apply to most claim objections. Instead, service of the claim objection by first-class mail on the person most recently designated to receive notices on the original or amended proof of claim will suffice. Exceptions apply to claims by the United States, its officers or agencies, or an insured depository institution. For those claimants, Rule 7004’s service requirements will continue to apply. Rule 3007 also more expressly permits giving notice and only an opportunity to request a hearing, rather than requiring an actual hearing, a practice that has become common in many districts.
  • Rule 3012 now permits determination not only of the amount of a secured claim under Section 506(a) but also of the amount entitled to priority under Section 507, and either by motion or claim objection. As amended the rule now provides that the amount of governmental unit’s secured claim can only be determined by motion or claim objection after the governmental unit has either filed a proof of claim or the time for doing so has expired.
  • Rule 7001 has been revised to reflect the changes made to Rule 3012.
  • Rule 9009 now more clearly requires the use of Official Forms and limits the types of acceptable alterations, essentially to only minor revisions to expand or delete spaces or delete items checked with “no” or “none.”

Evidence Please. Two Federal Rules of Evidence have been amended as well. First, the “ancient document” hearsay exception in Rule 803(16) has been changed to remove the “at least 20 years old” language and insert insert “prior to January 1, 1998.” The Advisory Committee’s concern is that going forward the old language could be used to admit “vast amounts of unreliable electronically stored information.” Other revisions, to Federal Rules of Evidence 902(13) and 902(14), create procedures for establishing the authenticity of electronic records without a testifying witness.

Did Someone Mention A Redline? Everybody loves to see a redline, so follow the link in this sentence for the complete set of rule changes, including redlines showing the revisions made, as well as the Advisory Committee’s explanations for each amendment.

Get Ready. The amendments take effect on December 1, 2017 so read up now and be ready for the changes taking effect in business bankruptcy cases in just a few weeks.

Business Bankruptcy Issues Recent Developments

Official Bankruptcy Forms Revised To Reflect April 1, 2016 Dollar Amount Adjustments Now In Effect

As discussed in an earlier post called “Going Up: Bankruptcy Code Dollar Amounts Will Increase On April 1, 2016,” various dollar amounts in the Bankruptcy Code and related statutory provisions were increased for cases filed on or after today, April 1, 2016. This information sheet has a list of all the dollar amount changes now in effect.

The official bankruptcy forms have also been revised to reflect these new dollar amounts.

Remember, the increased dollar amounts, now reflected on these forms, apply only to cases filed on or after April 1, 2016.

Business Bankruptcy Issues Recent Developments

Major Overhaul Of Federal Bankruptcy Forms, Plus An Accompanying Rule Amendment, To Take Effect December 1, 2015

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Almost every year, changes are made to the set of rules that govern how bankruptcy cases are managed — the Federal Rules of Bankruptcy Procedure. The changes address issues identified by an Advisory Committee made up of federal judges, bankruptcy attorneys, and others. Often there are revisions to the official bankruptcy forms as well.

One Little Rule Amendment? This year’s amendments impact only one rule, Federal Rule of Bankruptcy Procedure 1007. On the surface, the change is only a small revision to a reference to one of the official bankruptcy schedules. A link to a copy of the amendment, including the transmittal correspondence and a clean and redline version, can be found using the link in this sentence (and if you keep reading you will get the amendments to the Federal Rules of Civil Procedure as a bonus).

Big Changes Are Coming To The Bankruptcy Forms. Don’t let the minor rule amendment fool you. As one presidential candidate these days might put it, the changes coming to the official bankruptcy forms are “huge.”

  • As part of a modernizing of the official forms, virtually every bankruptcy form is being substantially revised.
  • Many forms, including the bankruptcy petition, list of 20 largest creditors, bankruptcy schedules, and statement of financial affairs, will now have customized versions for cases involving individual and non-individual debtors. The non-individual voluntary petition form pictured at the beginning of this post gives you an idea of how different the new forms look.
  • Going forward, business bankruptcy cases filed by corporations, LLCs, and partnerships will use a set of forms designed specifically for businesses instead of having to respond to questions meant for individuals.
  • The numbering system for the official bankruptcy forms is also changing. For example, forms bearing numbers in the 100 sequence will be reserved for individual debtors while those in the 200 sequence will apply to non-individual and business debtors.

Read All About It: Access The Revised Bankruptcy Forms. The U.S. Courts system has made the revised bankruptcy forms available now so you can get ready for the changes.

Get Ready. These major changes go into effect December 1st so bankruptcy attorneys and others should take the time now to review the new forms and get ready to use them.

Business Bankruptcy Issues Recent Developments

Mandatory Subordination: How Even A Money Judgment Can Be Treated Like Equity In Bankruptcy

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When an insolvent entity files for bankruptcy, it can be tough to be a creditor. But holding equity — stock in a corporation or a membership interest in an LLC, a limited liability company — can be even worse. Under bankruptcy’s “absolute priority rule,” creditors generally must be paid in full before equity gets anything. That usually means that holders of equity, or claims treated as equity, get nothing.

Section 510(b) Mandatory Subordination. A recent decision by the U.S. Court of Appeals for the Ninth Circuit in In re Tristar Esperanza Properties, LLC serves as a good reminder of the special bankruptcy rules involving mandatory subordination of certain equity-like claims. More on the Tristar case in a minute, but first let’s take a look at the provision that spells out the mandatory subordination rule. Section 510(b) of the Bankruptcy Code provides:

For the purpose of distribution under this title, a claim arising from rescission of a purchase or sale of a security of the debtor or of an affiliate of the debtor, for damages arising from the purchase or sale of such a security, or for reimbursement or contribution allowed under section 502 on account of such a claim, shall be subordinated to all claims or interests that are senior to or equal the claim or interest represented by such security, except that if such security is common stock, such claim has the same priority as common stock.

Whole Categories Of Claims Subordinated. Unlike equitable subordination of claims under Section 510(c) of the Bankruptcy Code, which the bankruptcy court may impose if the specific circumstances merit it, Section 510(b) subordination is mandatory and applies to entire categories of claims. These include securities fraud or rescission claims, whether individually or as part of a class action, against the bankrupt company arising from the purchase or sale of its stock or other security.

  • A securities fraud claim by current or former stockholders alleging fraud in the purchase of common stock, leading to damages when the stock price dropped? Subordinated to the level of common stock.
  • A lawsuit for damages to stockholders for breach of an agreement to register or issue shares of common stock? Subordinated to the level of common stock.
  • A lawsuit seeking to rescind a purchase of common stock, and get back the purchase price, due to alleged fraud? Subordinated to the level of common stock.
  • A judgment in any of those cases against the issuer of the stock? You guessed it — subordinated to the level of common stock.

Why Are These Claims Subordinated? Congress enacted Bankruptcy Code Section 510(b), as one court said, “to prevent disappointed shareholders . . . from recouping their investment in parity with unsecured creditors.” Put another way, Section 510(b) ensures that claims of true creditors are not diluted by claims of stockholders or former stockholders seeking damages arising from their stock interests.

  • As the old saying goes, creditors just want to get paid. Stockholders, on the other hand, invest risk capital in hopes of sharing in a company’s profits and “upside” potential. With that chance, however, comes the risk of losing their equity investment.
  • If claims arising out of the purchase or sale of securities were not subordinated, creditors would recover less and shareholders (or former shareholders) would effectively be paid on the same level as creditors, not below them as the absolute priority rule dictates.
  • To avoid this outcome, the Bankruptcy Code imposes mandatory subordination on these types of equity-related claims, preventing shareholders from transforming an equity-like claim into a judgment or proof of claim entitled to creditor treatment in bankruptcy.
  • As a side note, mandatory subordination is similar in concept but nevertheless different from recharacterization of a debt as equity, which involves an analysis on a case by case, rather than category, basis.

Subordination Only As To The Bankrupt Entity. The fact that these claims are subject to mandatory subordination in a bankruptcy of the issuer or its affiliate does not mean that securities fraud or other claims will be subordinated against third parties, including underwriters or directors and officers, or that insurance proceeds might not still be available to settle those claims. However, once an issuer files bankruptcy, claims against its assets in the bankruptcy estate will face mandatory subordination.

Are There Any Exceptions? Lower courts have held that mandatory subordination does not apply to convertible promissory notes where the conversion feature was never invoked, or to an “old and cold” promissory note for an equity repurchase made many years before the bankruptcy (although in the Tristar decision the Ninth Circuit noted that it was not reaching that issue). The Ninth Circuit held in In re American Wagering, Inc., 493 F.3d 1067 (9th Cir. 2007), that a claim under an employment agreement, where the claimant was never an equity investor and compensation was simply calculated based on the price of stock, should not be subordinated under Section 510(b). Depending on the circumstances, particular claims might be subject to an equitable subordination challenge under Section 510(c) of the Bankruptcy Code but, as noted, that is a separate legal standard and analysis.

The Tristar Esperanza Properties Decision. On April 2, 2015, the U.S. Court of Appeals for the Ninth Circuit issued a 12-page decision in In re Tristar Esperanza Properties affirming the lower courts’ decisions to subordinate under Section 510(b) a money judgment in favor of Jane O’Donnell, a member of the LLC. O’Donnell had exercised her right to withdraw from the LLC and require Tristar to purchase her membership interest based on the valuation procedure in the LLC operating agreement. She and Tristar could not agree on a valuation, and O’Donnell brought an arbitration action, receiving a $410,000 award in her favor. When Tristar failed to pay she confirmed the arbitration award in state court and got a state court judgment.

  • Less than a year later Tristar filed a Chapter 11 bankruptcy case, and O’Donnell filed a proof of claim based on the state court judgment.
  • Tristar filed an adversary proceeding seeking to subordinate her claim under Section 510(b), among other challenges. The bankruptcy court granted Tristar summary judgment and the Bankruptcy Appellate Panel affirmed.
  • On appeal to the Ninth Circuit, O’Donnell’s main arguments were that although her LLC membership interest was a security of the debtor, her claim was neither for “damages” nor “arising from the purchase or sale” of the membership interest.
  • The Ninth Circuit rejected both arguments, interpreting both clauses of Section 510(b) broadly.
    • First, it held that her claim was for “damages,” in this case for breach of contract, and Section 510(b)’s damages clause should be read broadly. It rejected her argument that fixed, admitted debts should be excluded from the scope of “damages” in Section 510(b), noting that the very broad definition of “claim” in Section 101(5)(A) of the Bankruptcy Code makes no such distinction.
    • Second, even though O’Donnell was a judgment creditor and no longer an equity holder at the time Tristar filed bankruptcy, the Ninth Circuit emphasized that Section 510(b) applies if a creditor claim “arises from the purchase or sale of a security.” A claim will be subordinated if there is a sufficient nexus or causal relationship between the claim and the purchase or sale of securities.

The Ninth Circuit’s Rationale. The Ninth Circuit elaborated on the rationale for mandatory subordination, quoting from its earlier decision in In re Betacom of Phx., Inc., 240 F.3d 823 (9th Cir. 2001) and explaining:

Our straightforward reading of the ‘arises from’ language in § 510(b) comports with congressional intent. As we have said, ‘[t]here are two main rationales for mandatory subordination: 1) the dissimilar risk and return expectations of shareholders and creditors; and 2) the reliance of creditors on the equity cushion provided by shareholder investment.’ Although O’Donnell did not enjoy the benefits of equity ownership on the date of the petition, she bargained for an equity position and thus embraced the risks that position entails.

Conclusion. The Ninth Circuit is essentially telling investors “once a shareholder, always a shareholder,” at least if a claim in bankruptcy arises from an equity interest. Even though O’Donnell had transformed her LLC membership interest into a money judgment, it was still subordinated and treated like equity. This new decision reminds us once again that Section 510(b)’s mandatory subordination rules impact entire categories of claims and make it extremely difficult to collect on any equity-like claim in bankruptcy.

 

Image Courtesy of Flickr by Ervins Strauhmanis

Business Bankruptcy Issues

Cooley GO: A Great New Resource For Entrepreneurs And Their Companies

Cooley Go

Cooley GO

Earlier this month, Cooley LLP launched Cooley GO, a terrific new resource center for entrepreneurs with businesses at all stages of the growth cycle. Cooley GO is a mobile-friendly microsite that provides a wide range of free legal and business content covering formation, financing, building a team, working with directors and advisors, intellectual property, M&A, IPOs and more.

I have the pleasure of being a contributor to Cooley GO. A new post I wrote called “A Key Customer Filed for Bankruptcy: Should You Keep Doing Business With Them?” is now on the Cooley GO site. To read the article just follow the link in the prior sentence.

Be sure to explore the full Cooley GO site. Among other tools, Cooley GO provides entrepreneurs with the ability to:

I hope you find Cooley GO to be a helpful resource for your business.

Business Bankruptcy Issues

Why Creditors Can’t Afford To Ignore Objections To Bankruptcy Claims

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It’s been several years since I last posted about objections to bankruptcy claims, and the topic is so important to creditors that it’s time to revisit it.

File And Forget? When a customer or other party with which you do business files bankruptcy, it’s important to file a proof of claim on time by the deadline (also known as a “bar date”) set in the case. Once you do, however, months or even years can go by before you hear anything more about your claim from the debtor, bankruptcy trustee, or other party responsible for reviewing claims and ultimately distributing money to creditors. In fact, the only thing you may hear about your claim for quite some time is an offer to purchase it made by one or more claims buyers.

No News Is Not Necessarily Good News About Your Claim. Unfortunately, the passage of time may lull you into thinking that no objection will ever be filed to your claim. However, the urgency of reorganizing a debtor’s business or liquidating its assets means that the claim objection process is typically left until near the end of the bankruptcy case, often after a plan of reorganization has been confirmed in a Chapter 11 case. Likewise, a Chapter 7 trustee may put off filing claim objections until it’s clear there will be money to distribute to unsecured creditors. As a result, an objection to your claim may be brought long after you filed it, often years later.

Is That An Objection To My Claim? When an objection is filed, it may not always be obvious at first that it applies to your claim. In smaller cases the title of a claim objection may list your name as the target of the objection, but don’t count on that in larger cases. In cases with hundreds or thousands of claims, the debtor or other estate representative will almost certainly combine an objection to your claim with others. Instead of a pleading specifically mentioning your name in its title or text, the objection will likely have the word “omnibus” in it and may have a name such as “Notice of Debtors’ One Hundred Fifteenth Omnibus Objection To Claims (No Liability)” or some similarly titled document.

  • Be careful: the format of these objections can be a trap for the unwary. Buried within the objection’s many pages of text and attached exhibits may be just a few lines, often only in a list or chart, identifying your claim as one of dozens to which an objection has been filed.
  • Given the passage of time, the debtor may have sold — and changed — its name, so the name of the debtor listed on the objection may not even be familiar to you (although the old name should appear near the new one).
  • When filed, the objection may assert (1) your claim should be zero, (2) the amount doesn’t square with the debtor’s books and records and should be less, or (3) your claim should be reclassified as some lower priority claim (for example, from a priority claim to a general unsecured claim).
  • Whatever the objection’s name or format, the point is the same: ignore it at your peril. If you don’t file a formal response with the bankruptcy court by the deadline set in the objection (and there’s always a deadline) your claim could be disallowed in its entirety. If that happens, you will recover absolutely nothing from the bankruptcy estate.

Stay Vigilant To Protect Your Rights. Protecting your rights in a bankruptcy case requires diligence and timely action — often no easy task. In mega bankruptcy cases, literally thousands of pleadings can be filed during the course of a case. Many will be served, whether in paper or electronic form, and yet only a few may be directly relevant to you or your claim. For this reason, it’s critical that you or your attorney keep track of the pleadings served in a bankruptcy case. The bottom line is, if you see anything that looks like a claim objection, review all of the pages carefully, including the exhibits. If an objection to your claim is filed, you have to respond on time and defend your claim. Otherwise, despite your efforts earlier in the case to file a timely proof of claim, you may well find yourself with a disallowed, and worthless, claim.

Image Courtesy of Flickr by Sam Howzit

Business Bankruptcy Issues Recent Developments

Official Bankruptcy Forms Revised To Reflect April 1, 2013 Dollar Amount Adjustments

As discussed in an earlier post called "Going Up: Bankruptcy Dollar Amounts Will Increase On April 1, 2013," various dollar amounts in the Bankruptcy Code and related statutory provisions were increased for cases filed on or after today, April 1, 2013. Now several official bankruptcy forms have been revised to reflect these new dollar amounts.

Remember, the increased dollar amounts reflected on these forms apply only to cases filed on or after April 1, 2013.