Recent Developments

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Business Bankruptcy Issues Recent Developments

If Madoff Investors Are Sued By The SIPA Trustee And Pay Money Back, Can They File Proofs Of Claim After The Bar Date?

Recently, I posted about SIPA liquidations of brokerage firms, prompted by the Securities Investor Protection Act (known as SIPA) liquidations of Lehman Brothers, Inc. and Bernard L. Madoff Investment Securities LLC. An interesting issue has come up in the Madoff case involving investors who redeemed their accounts before the Madoff bankruptcy was filed. In other alleged Ponzi scheme cases, trustees have sued such investors asserting fraudulent transfer or other claims. The investors in turn often raise defenses, including that they redeemed their accounts in good faith and without any knowledge of the alleged fraud, and lengthy and complex litigation usually results.

Resolution of such litigation can come long after the deadline set for filing proofs of claim (known as a "bar date"). This raises a question: if investors end up paying money back to the estate as a result of the trustee’s litigation, will they be able to file proofs of claim — after the bar date — for the amounts they have to return? Before turning to that question, let’s take a look at how such post-bar date claims are dealt with in non-SIPA bankruptcy cases.

Section 502(h) Of The Bankruptcy Code. Under the Bankruptcy Code, if a person or entity is sued by the bankruptcy estate (usually by a trustee, the debtor in possession, or a creditors’ committee) for receipt of an alleged preference or fraudulent transfer, they will be able to file a proof of claim if they end up paying money back to the bankruptcy estate in settlement or as a result of a judgment. Bankruptcy Code section 502(h) expressly covers this situation:

(h) A claim arising from the recovery of property under section 522, 550, or 553 of this title shall be determined, and shall be allowed under subsection (a), (b), or (c) of this section, or disallowed under subsection (d) or (e) of this section, the same as if such claim had arisen before the date of the filing of the petition.

Section 502(h) recognizes that resolution of avoidance actions may come long after the original bar date for filing proofs of claim has past and allows holders of these later-arising claims to share in the estate along with other creditors. The Bankruptcy Code treats these claims as having arisen at the time of the payment back to the bankruptcy estate and allows proofs of claim to be filed months or even years after the bar date. 

The Claims Bar Date In SIPA Liquidations. In a SIPA liquidation, there are generally two claims bar dates. The first bar date set is for customer claims, in which customers of the failed brokerage firm seek to recover the securities in their accounts (or more likely in the Madoff case, the securities that were supposed to have been in their accounts). The Securities Investor Protection Corporation insurance of up to $500,000 applies to customer claims. A second bar date, usually a few months later, is for general claims. General creditors may include customers with claims in excess of the $500,000 SIPC protection or those who have more traditional trade creditor or other claims. 

The Madoff Case. In the Madoff case, last month several investors filed a motion seeking to have the bar date order clarified with regard to their potential claims in the event that the Madoff trustee later sued them and they were forced to return funds under a fraudulent transfer or other avoidance (sometimes called a  "clawback") cause of action after the general claims bar date.

  • These investors had previously redeemed some or all of their investments, and were seeking an order holding that claims arising from avoidance actions could be filed within 30 days after the judgment giving rise to the claim became final, a provision common in non-SIPA bankruptcy bar date orders due to Bankruptcy Code section 502(h).
  • The moving parties were concerned that without this clarification, any such claims they filed after the bar date might be held to be barred. On the other hand, if they were forced to file a protective claim before the bar date, they would submit to the court’s equitable jurisdiction and may be held to have waived their right to a jury trial in any avoidance action brought against them.
  • The Madoff trustee filed an opposition to the motion (copy available at the prior link) arguing, among other things, that these investors were not creditors, had not been sued, and as a result did not present an actual case or controversy ripe for adjudication. In addition, the trustee argued that Section 502(h) of the Bankruptcy Code was inapplicable, contending that it was inconsistent with an absolute bar date provision under SIPA. (The SIPA statute provides that Bankruptcy Code provisions are generally applicable in SIPA cases to the extent consistent with SIPA.)
  • The SIPC also filed a response to the motion (copy available at the prior link) making arguments similar to those advanced by the trustee. In particular, the SIPC argued that Section 502(h) was inconsistent with what the SIPC called SIPA’s "immutable" bar date.

The Court’s Decision. In a five-page decision issued on February 24, 2009, U.S. Bankruptcy Judge Burton R. Lifland denied the motion, first holding that the Court did not have the discretion to extend the bar dates involved. (A copy of the decision is available by clicking on the link in the prior sentence.) The Court then stated that the motion essentially sought a determination of whether Section 502(h) of the Bankruptcy Code was applicable in SIPA liquidations. Because no avoidance action had yet been filed, the Court held that the requested relief, if granted, would amount to an improper advisory opinion.

  • As a result, the Court refused to decide whether Bankruptcy Code Section 502(h) applies in SIPA cases, commenting as follows: "Although section 78fff(b) of SIPA specifies that the provisions of the Bankruptcy Code shall apply in SIPA liquidation proceedings, to the extent that they are consistent with SIPA, it is unclear whether section 502(h) of the Code would apply. 15 U.S.C. § 78fff(b) (1981)."
  • The Court concluded by noting that the investors could file a protective proof of claim before the general claims bar date, although that would subject them to the Court’s equitable jurisdiction.

An Open Question. Although the Court denied the motion, it left open the ultimate issue involved — whether Section 502(h) of the Bankruptcy Code applies in SIPA liquidations and permits parties to file proofs of claim after the bar date if they are sued by a trustee and later have to return funds or other property. With the issue undecided for now, some investors may choose to file a protective proof of claim before the bar date passes.

Business Bankruptcy Issues Recent Developments

New Article Looks At BAPCPA’s Impact On Retailers In Chapter 11

My colleagues Lawrence C. Gottlieb, Michael Klein, and Ronald R. Sussman recently authored an article entitled "BAPCPA’s Effects on Retail Chapter 11s Are Profound," in the February 2009 edition of the The Journal of Corporate Renewal, published by the Turnaround Management Association. You can access a copy of the article by clicking on its title in the prior sentence.

What’s their assessment of the impact of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (known as BAPCPA) on retailer Chapter 11 bankruptcies? Here’s an excerpt:

BAPCPA’s numerous creditor-friendly amendments and modifications have profoundly impacted the Chapter 11 process, to the point that it is nearly impossible for retailers to reorganize, regardless of the prevailing national and international economic conditions.

Time and again in the three years since its enactment, BAPCPA has significantly impaired the ability of retailers to obtain the necessary post-petition financing and breathing room from creditors to test and implement a reorganization strategy, regardless of the debtor’s capital structure, the fluctuating state of the credit markets, or the extent to which they compete with large discount retailers like WalMart or online retailers like Amazon.

The article details several of the critical changes BAPCPA made, their effect on retailers, and how the timing of a bankruptcy filing is often critical for a retailer to have any chance of trying for a going concern sale to avoid complete liquidation through going out of business sales.

The Cooley Bankruptcy & Restructuring Group, which Lawrence Gottlieb chairs, is representing official committees of unsecured creditors in many high-profile national and regional retail bankruptcies, including Steve & Barry’s, The Bombay Company, Hancock Fabrics, Lillian Vernon, The Sharper Image, Mervyns, Shoe Pavilion, Boscov’s and Goody’s. The article, drawn from these recent experiences, is important reading for retailers, creditors, and insolvency professionals alike.

Business Bankruptcy Issues Recent Developments

Free Online Bankruptcy Research Tool Now Updated

Last year I posted about the research binder that Chief Judge Randall J. Newsome of the United States Bankruptcy Court for the Northern District of California makes available to bankruptcy professionals and the public. Well, Chief Judge Newsome has now updated his binder as of February 5, 2009, covering cases through Volume 395 of Bankruptcy Reports. Follow the links in this sentence to access the entire binder in PDF format and the HTML version organized by topic. The PDF version is capable of being searched using a key word or phrase.

The primary focus of the research binder is on Ninth Circuit law given that Chief Judge Newsome presides in the Northern District of California, but some out-of-circuit law is also included. The disclaimer Chief Judge Newsome includes puts the binder’s use in context:

The following list of cases and supplemental information is presented for informational and educational purposes only. Though it represents the aggregation of 19 years of research, the Court makes no claims as to its current level of accuracy. Some of the cases set forth may very well have been superseded, reversed, or otherwise may no longer be good law. The Court has posted it with the intention to educate and assist those who may find it helpful. Accordingly, users should consider it a first, but by no means final, research tool, and should cite check all cases listed herein for continued viability prior to relying on such cases in practice.

With those comments in mind, the binder can be a very helpful place to start when researching bankruptcy law issues in Ninth Circuit.

Business Bankruptcy Issues Recent Developments

Amendments To The Federal Bankruptcy Rules Take Effect December 1, 2008

Nearly every year, changes are made to the Federal Rules of Bankruptcy Procedure — the ones that govern how bankruptcy cases are managed — to address issues identified by an Advisory Committee made up of federal judges, bankruptcy attorneys, and others. This year’s amendments to the national bankruptcy rules take effect on December 1, 2008. 

Business Bankruptcy Rule Changes. Unlike the more substantive modifications made last year (discussed here), this year’s amendments make a host of relatively smaller, but still important, changes. The most notable ones for business bankruptcy cases involve privacy concerns. New rules have been put in place to protect patients when health care businesses file for bankruptcy while others govern the proposed sale or transfer of personally identifiable information by any type of business. Separate rule changes implement provisions of Chapter 15 (the Bankruptcy Code’s cross-border and international insolvency chapter), address a range of issues in small business Chapter 11 cases, grant courts more flexibility in giving notice to foreign creditors, introduce various consumer bankruptcy procedural changes, and establish a process to allow some bankruptcy court decisions to be appealed directly to the U.S. Court of Appeals.

Interim Bankruptcy Rules Being Replaced. These rules also replace the interim bankruptcy rules that have been in place for the past few years following the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (known as BAPCPA). Some bankruptcy courts, such as the District of Delaware and the Southern District of New York, have already issued general orders retracting the effectiveness of the interim rules effective as of December 1, 2008.

Rules Of The Road. At a time when the financial crisis is likely to push more and more companies into Chapter 11, bankruptcy attorneys and other insolvency professionals will want to review the rule changes closely to make sure they are following the most current version of the Federal Rules of Bankruptcy Procedure. For debtors, creditors, and other parties, this year’s rule amendments should help make management of Chapter 11 bankruptcy cases more consistent with BAPCPA’s changes and, potentially, a more efficient process.

Business Bankruptcy Issues Recent Developments The Financially Troubled Company

Fall 2008 Edition Of Bankruptcy Resource Is Now Available

The Fall 2008 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:

  • Claims and defenses under the WARN Act;
  • The Supreme Court’s decision on transfer taxes and bankruptcy sales;
  • Section 363 "free and clear" sales in bankruptcy; and
  • The interplay between claim objections and the Section 503(b)(9) "20 day goods" administrative claim.

This edition also has information 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, Hancock Fabrics, Steve & Barry’s, Goody’s, Sharper Image, The Bombay Company, and Shoe Pavilion, among others. In addition, a note from my partner Adam Rogoff, the editor of Absolute Priority, discusses how the current economic problems will require lenders, unsecured creditors, and others to consider the impact of Chapter 11 bankruptcy on their rights.

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

Business Bankruptcy Issues Recent Developments

The 2005 Bankruptcy Law Changes And Their Impact On Retail Reorganizations

On September 26, 2008, my partner Lawrence Gottlieb, the Chair of the Bankruptcy & Restructuring Group at Cooley Godward Kronish LLP, testified before the Subcommittee on Commercial and Administrative Law of the United States House of Representatives Committee on the Judiciary.  Joining him at the hearing were Professor Jay Westbrook of the University of Texas Law School and Professor Barry Adler of the New York University School of Law. The subject of the hearing was "Lehman Brothers, Sharper Image, Bennigan’s, and Beyond: Is Chapter 11 Bankruptcy Working?" You can access their testimony and watch the full hearing by clicking on the link in the prior sentence.

In his testimony, entitled "The Disappearance of Retail Reorganization In The Post-BAPCPA Era," (a copy of which is available by clicking on its title), he discussed the major impact the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA") has had on retail reorganizations. One of his main observations involves the 2005 amendment limiting the time within which a debtor may assume or reject commercial real estate leases to a total of 210 days (if a 90-day extension is granted). He testified that this change, in combination with other BAPCPA provisions that reduce a retailer’s liquidity, has had a devastating effect on a retailer’s ability to reorganize. Among his comments are the following:

BAPCPA has left retailers without adequate time and money to effectuate operational initiatives and cost cutting measures needed to resuscitate their businesses. Retailers now enter the Chapter 11 arena with little choice but to narrowly tailor their strategy to ensure that their lenders are not deprived of the substantial benefits and protections conferred by section 363(b) of the Bankruptcy Code, which authorizes the use, sale or lease of estate property outside the ordinary course of business upon court approval. Section 363(b) offers the unique ability to cleanse the assets of a distressed company by permitting debtors to convey assets “free and clear,” thereby maximizing value by removing the uncertainty of such stigmas as successor liability, fraudulent transfer claims and lien issues that often accompany asset purchases. Prepetition lenders, cognizant of this powerful liquidating tool and mindful of the numerous liquidity hurdles that the debtor must clear as a result of BAPCPA, have little to gain by risking their collateral in pursuit of a reorganization process now widely perceived as hopeless.

Indeed, the constricted time frames and liquidity problems created and imposed by BAPCPA have effectively eliminated the need for existing lenders to provide any more financing than necessary to position the debtor to liquidate its assets in the first few months of the case. Today, the debtor is no longer “in possession” of its assets or its future upon the commencement of its Chapter 11 case. BAPCPA’s constrictive liquidity provisions and the enormous leverage handed to secured lenders as a result thereof have eliminated the ability of retailers to control the Chapter 11 process as a “debtor-in-possession.” Rather, the process is now controlled almost exclusively by prepetition lenders, who have essentially assumed the role of "creditor-in-possession." 

The Cooley Bankruptcy & Restructuring Group, which Lawrence Gottlieb chairs, is representing official committees of unsecured creditors in high-profile national and regional retail bankruptcies such as Steve & Barry’s, The Bombay Company, Hancock Fabrics, Lillian Vernon, The Sharper Image, Mervyns, Shoe Pavilion, Boscov’s and Goody’s. His testimony, drawing on experience in these recent cases as well as many others in the past, underscores how BAPCPA’s key changes have transformed Chapter 11 bankruptcy from a process by which retailers could reorganize into one where almost all face an early liquidation. Retailers, creditors, and insolvency professionals will find his full testimony on the disappearing retail reorganization both timely and informative.

Business Bankruptcy Issues Recent Developments

The Credit Crisis And DIP Financing

The credit crisis has made it difficult for companies to borrow throughout the economy. It should come as little surprise then that the constriction in the credit markets is hitting Chapter 11 debtors in possession as well. According to an article entitled "Bankruptcy financing gets pricier and more elusive," debtor in possession financing (commonly known as "DIP financing") has recently become more costly for companies in Chapter 11 bankruptcy — when it’s available at all.

  • Adding to the challenge is the amount of prepetition secured financing, including second lien debt, that many companies took on over the past few years when financing was easier to get. A company that has already encumbered its assets with secured debt may have little or no unencumbered assets to offer a DIP lender as collateral.
  • The article predicts that fewer companies in Chapter 11 will be able to find new lenders to provide DIP financing, giving the DIP’s existing lenders the advantage in negotiating DIP financing terms such as interest rate and fees.
  • Alternative sources of DIP financing may be able to be found in certain circumstances. In some cases, the buyer in a Section 363 asset sale may provide DIP financing to bridge to the closing of the sale. However, such limited purpose financing is not a substitute for the type of DIP financing generally needed for a successful reorganization.

Cash is king in bankruptcy and DIP financing is often a key source of that cash. Until the credit crisis subsides and DIP financing becomes more available, companies may find it more difficult to reorganize in Chapter 11.