BANKRUPTCY UPDATE January 2014 Recent Developments in Bankruptcy Law (Covering cases reported through 501 B.R. 843 and 734 F.3d 431) CRAVATH, SWAINE & MOORE LLP This update relates to general information only and does not constitute legal advice. Facts and circumstances vary. We make no undertaking to advise recipients of any legal changes or developments. Richard B. Levin Cravath, Swaine & Moore LLP Worldwide Plaza 825 Eighth Avenue New York, NY 10019-7475 (212) 474-1978 [email protected] 1. AUTOMATIC STAY 1 1.1 1.2 1.3 Covered Activities Effect of Stay Remedies 1 1 1 2. AVOIDING POWERS 1 2.1 2.2 2.3 2.4 2.5 2.6 2.7 Fraudulent Transfers Preferences Postpetition Transfers Setoff Statutory Liens Strong-arm Power Recovery 3. BANKRUPTCY RULES 4. CASE COMMENCEMENT AND ELIGIBILITY 4.1 4.2 4.3 5. 5.1 5.2 5.3 5.4 5.5 6. 6.1 6.2 Eligibility Involuntary Petitions Dismissal CHAPTER 11 Officers and Administration Exclusivity Classification Disclosure Statements and Voting Confirmation, Absolute Priority CLAIMS AND PRIORITIES Claims Priorities 1 2 2 2 2 2 3 4 4 4 4 4 5 5 5 5 5 5 7 7 7 7. CRIMES 8 8. DISCHARGE 8 8.1 8.2 8.3 General Third-Party Releases Environmental and Mass Tort Liabilities 8 8 8 9. EXECUTORY CONTRACTS 9 10. INDIVIDUAL DEBTORS 10 10.1 10.2 10.3 10.4 10 10 10 10 Chapter 13 Dischargeability Exemptions Reaffirmation and Redemption 11. JURISDICTION AND POWERS OF THE COURT 10 12. PROPERTY OF THE ESTATE 11 12.1 Property of the Estate 12.2 Turnover 12.3 Sales 11 12 12 13. TRUSTEES, COMMITTEES, AND PROFESSIONALS 12 14. TAXES 15 15. CHAPTER 15—CROSS-BORDER INSOLVENCIES 15 11.1 11.2 11.3 11.4 13.1 13.2 13.3 13.4 13.5 Jurisdiction Sanctions Appeals Sovereign Immunity Trustees Attorneys Committees Other Professionals United States Trustees 10 10 10 11 12 13 14 14 15 1. AUTOMATIC STAY 1.1 Covered Activities 1.2 Effect of Stay 1.3 Remedies 2. AVOIDING POWERS 2.1 Fraudulent Transfers 2.1.a. “Collapsing” allows application of the section 546(e) safe harbor. Duke indirectly owned 100% of Crescent. Duke formed Holdings and contributed its interests in Crescent to Holdings. Crescent borrowed $1.2 billion from a bank syndicate and distributed the loan proceeds to Holdings, who distributed them to Duke. A third party purchased 49% of Holdings from Duke for $414 million. Holdings issued 2% of its stock to its CEO under an employment contract. The result is that Duke spun off 51% of Crescent. Crescent filed bankruptcy within three years. The trustee sought to recover the $1.2 billion payment to Duke as a fraudulent transfer. Section 544(b), effectively incorporating state fraudulent transfer law, permits the trustee to avoid a transfer within four years before bankruptcy of an insolvent debtor’s property for less than reasonably equivalent value. However, section 546(e) prohibits a trustee from avoiding a transfer, by or to a financial institution, that is a settlement payment or made in connection with a securities contract. “Settlement payment” is broadly defined to include any payment that settles a securities transaction. A securities contract is a contract for the purchase or sale of a security. In this case, the Crescent distribution to Duke was part of a series of integrated transactions in which securities in Crescent were purchased and sold. Crescent would not have made the distribution but for the securities transactions. Therefore, the distribution was a payment made to settle a securities transaction. In addition, it was made in connection with a securities contract, the purchase and sale of the Crescent securities. Therefore, the court dismisses the trustee’s claim. Crescent Resources Litigation Trust v. Duke Energy Corp., 500 B.R. 464 (W.D. Tex. 2013). 2.1.b. “Collapsing” is a two-way street, and an auction produces reasonably equivalent value. The U.K. debtor operated a global business. All its subsidiaries guaranteed its principal secured debt. It filed administration proceedings in the U.K., and the secured lender appointed a receiver in Ireland. The administrator and the receiver conducted an extensive marketing program for the debtor’s global business, identifying several serious bidders. They ultimately sold the entire business in a single transaction, though using a separate agreement for the U.S. business because the U.S. assets were not being administered in the administration or receivership. The agreements did not allocate the purchase price between the two agreements, except for tax purposes, because the total purchase price was less than one-third of the secured debt, and the proceeds were all paid to the secured lender. The U.S. debtors later filed a bankruptcy case. The trustee sought to avoid and recover the transfer to the buyer of the U.S. assets as a fraudulent transfer. Section 548(a) permits the trustee to avoid a transfer of property of an insolvent debtor for less than reasonably equivalent value. A court may collapse separate transactions into a single transaction for legal analysis purposes if the separate transactions are steps in a single integrated transaction. Although courts collapse separate transactions in a leveraged buyout to find a fraudulent transfer, the doctrine is not limited to that context or to finding a fraudulent transfer. It applies in analyzing any transaction so that form will not prevail over substance. Here, the separate agreements were so related that they should be collapsed and treated as a single transaction. Therefore, the value analysis must look to the entire sale, not only to the U.S. assets sale. Reasonably equivalent value does not require a “penny for penny” exchange if the values are roughly equivalent. Courts give marketplace values significant deference, and a winning bid at an auction is equivalent to fair market value. The value received here after the robust marketing process was reasonably equivalent value, so the court dismisses the trustee’s claim. Pereira v. WWRD US, LLC (In re Waterford Wedgwood USA, Inc.), 500 B.R. 371 (Bankr. S.D.N.Y. 2013). 2 2.2 Preferences 2.2.a. The filing of a lis pendens is not a transfer. The creditor sued the debtor to reform a mortgage on the debtor’s property that mistakenly named the debtor’s principal as the mortgagor. Within 90 days, the debtor filed bankruptcy. It sought to avoid the lis pendens as a preference. A preference requires a transfer of an interest in property of the debtor. Section 101(54) defines “transfer” as each mode of disposing or of parting with property or an interest in property. Federal law thus defines what constitutes a transfer, but state law defines property and interests in property. Under applicable state law, a lis pendens provides only notice to the world of the plaintiff’s claimed interest in the property and permits the plaintiff’s ultimate judgment, once obtained, to rank ahead of all intervening interest holders, but grants no interests in the property to the plaintiff. Therefore, the filing of the lis pendens is not a preferential transfer. Ute Mesa Lot 1, LLC v. First-Citizens Bank & Trust Co. (In re Ute Mesa Lot 1, LLC), 736 F.3d 947 (10th Cir. 2013). 2.2.b. Debt is incurred in the ordinary course if the transaction is ordinary, whether or not common. A coal mining debtor purchased on account a longwall electric system to construct a longwall mining operation, which differed from the continuous mining operation that the debtor had previously conducted, from a supplier who regularly sells such systems. The trustee sought to avoid the debtor’s payment to the supplier as a preference. Section 547(c)(2) provides an avoidance defense “to the extent that the transfer was in payment of a debt incurred in by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee” and the payment was in the ordinary course. A debt is incurred in the ordinary course if the transaction is an arm’s-length, commercial transaction that occurred in the marketplace, rather than, for example, an insider transaction. Whether the debtor has incurred similar debt or debt for a similar purpose is not relevant. “The transaction need not have been common; it need only be ordinary.” Therefore, this debt was incurred in the ordinary course of the debtor’s business. Rushton v. SMC Electrical Prods., Inc. (In re C.W. Mining Co.), 500 B.R. 635 (10th Cir. B.A.P. 2013). 2.3 Postpetition Transfers 2.3.a. Recoupment defense defeats action to avoid a postpetition transfer. The debtor produced milk and sold it to a customer. As was the custom in the industry, to insure a steady supply of milk, the customer advanced a portion of the purchase price for one month’s milk supply under an agreement that the debtor would continue to supply milk and the customer would deduct the advance amount, plus interest, in equal amounts from the amount owing for the debtor’s next 12 months of milk supply. The debtor filed a chapter 12 petition in the ninth month. The debtor continued to supply the customer, who continued to deduct the previously agreed amounts for the next three months. The case later converted to chapter 7. The trustee sued the customer under section 549 to avoid and recover the postpetition transfer of milk for which the customer had not paid the estate. Recoupment permits netting of a debt arising from a single transaction. A single transaction arises out of the same set of operative facts but does not include multiple occurrences in any continuous commercial relationship. Courts permit recoupment only when it would be inequitable for the debtor to enjoy the benefits of a transaction without meeting its obligations. Recoupment is a defense to an avoidance action under section 549. Here, the agreement between the debtor and the customer for milk supply and recovery of the customer’s advance makes each milk shipment and deduction part of a single transaction. Allowing recoupment is equitable because the transaction fostered the debtor’s reorganization efforts, and disallowing it would discourage others from providing similar financing. Therefore, the court dismisses the trustee’s action. Rainsdon v. Davisco Foods Int’l, Inc. (In re Azevedo), 497 B.R. 590 (Bankr. D. Ida. 2013). 2.4 Setoff 2.5 Statutory Liens 2.6 Strong-arm Power 2.6.a. Postpetition UCC continuation statement is not required to maintain perfection. The secured creditor’s financing statement expired six weeks after the petition date. The creditor did not file a continuation statement. After the financing statement expired, the creditor filed a proof of secured claim and sought adequate protection and stay modification. Section 544(a) gives the trustee the status of a hypothetical judicial lien creditor as of the commencement of the case. State law determines a lien’s validity. Under UCC section 9-317(a)(2), a judicial lien that arises before a security interest is perfected takes priority, implying that a judicial lien that arises after perfection does not. UCC section 9-515(c) 3 provides that upon a financing statement’s lapse, the security interest becomes unperfected and is treated as never having been perfected against a purchaser for value, but not as against a judicial lien creditor. The omission from the statute compels the conclusion that a lapsed financing statement does not give a judicial lien that arose before the lapse priority over the security interest. American Bank, FSB v. Miller Bros. Lumber Co., Inc. (In re Miller Bros. Lumber Co., Inc.), ___ B.R. ___, 2013 U.S. Dist. LEXIS 152176 (M.D.N.C. Oct. 23, 2013). 2.7 Recovery 2.7.a. Section 550(a) does not require an avoidance judgment before the trustee may recover from a subsequent transferee. The trustee settled a fraudulent transfer avoiding power action against the defendant and within one year, brought subsequent transferee recovery actions against transferees from the defendant. In the settlement, the defendant did not admit liability, and the judgment did not state that the trustee avoided the transfer to the defendant. The judgment provided simply that the defendant would pay the trustee a sum of money. Section 550(a)(2) provides that, “to the extent that a transfer is avoided …, the trustee may recover … the property transferred, or, if the court so orders, the value of such property” from a subsequent transferee. Under section 550(f), the trustee must bring the recovery action within one year after the trustee avoids the transfer. The “to the extent” phrase is ambiguous because it does not specify the defendant against whom the trustee must bring the action and suggests a limitation on the portion of a transfer that is avoided, not a temporal limitation requiring prior avoidance. Construing the provision as requiring an actual avoidance judgment would allow transferees to shelter transfers by re-transferring assets and would discourage a trustee from reaching settlements. Moreover, triggering recovery on avoidance alone would deny due process to a recovery defendant by preventing the defendant from asserting defenses to the underlying avoidance action to which the recovery defendant was not a party. Finally, a settlement provides as much finality as a judgment to trigger the section 550(f) statute of limitation, so the statute is not open-ended. Therefore, section 550(a) does not require an actual judgment of avoidance to permit the trustee to recover from a subsequent transferee. Sec. Inv. Protec. Corp. v. Bernard L. Madoff Inv. Secs. LLC, 501 B.R. 26 (S.D.N.Y. 2013). 2.7.b. Bank was not liable under section 550 in ACH kiting scheme. The debtor payroll service used a data processing service to help process fund transfers, including withholding taxes that it handled for its employer clients, through the automated clearing house (ACH) system. After the debtor misappropriated funds and was short, it began ”kiting” ACH transfers. It would issue a credit instruction, which would fund its account from the data processing service’s bank account, and simultaneously issue a debit instruction to the service’s bank account from another of its accounts. The debit instruction would fail, the service’s bank would debit the service’s account, the service would notify the debtor, and the debtor would wire funds to the service’s bank account. The trustee sued to avoid the wires and to recover the transfers from the service’s bank. Section 550 permits the trustee to recover an avoided transfer from an initial transferee, an entity for whose benefit a transfer is made or a subsequent transferee. An initial transferee is one who has dominion over the transferred property. The bank did not have dominion over the funds that the debtor wired to the service’s account because the bank had not extended credit to the debtor. So the debtor did not make the payment to the bank, who therefore was not an initial transferee. For the same reason, the bank was not an entity for whose benefit the transfer was made. The bank’s sole relationship was with its customer, the data processing service, who received the wired funds. Finally, the bank was not a subsequent transferee by reason of its debit of the service’s account, because there was no direct correlation between the debtor’s wire and the bank’s debit of the service’s account. Gugino v. Greater Rome Bank (In re Payroll America, Inc.), 498 B.R. 252 (D. Id. 2013). 2.7.c. Judgment creditor whose lien attaches automatically does not take for value. The debtor fraudulently transferred real property to one of its principals. The principal was subject to judgments in favor of third party creditors. Under applicable nonbankruptcy law, their judgments automatically became liens upon the real property when the principal acquired it. The trustee sued to avoid the transfer and recover the property. A company owned by the principal acquired the judgment liens from the third party creditors. Section 550(a) permits a trustee to recover fraudulently transferred property (or its value) from an initial or subsequent transferee. Under section 550(b), a subsequent transferee may assert as a defense that it acquired the property for value and in good faith. Value includes satisfaction or securing of an antecedent debt. The judgment lien creditors did not give anything in exchange for their judgment liens when they automatically attached. And the principal’s company did not take the liens in good faith, 4 because the series of transactions was simply an attempt to wash the fraudulent transfer through third parties. Therefore, the court awarded the trustee judgment against the principal. Infinity Real Estate Invs., LLC v. Roach (In re J.T. Real Estate Invs., LLC), 498 B.R. 869 (Bankr. N.D. Ind. 2013). 2.7.d. ERISA does not prevent fraudulent transfer recovery from a 401(k) plan. A 401(k) retirement plan withdrew investments with a Ponzi scheme debtor. The debtor’s trustee sued to recover the withdrawal as a fraudulent transfer. ERISA, 29 U.S.C. § 1056(d)(1), prohibits assignment or alienation of benefits under a plan. The purpose is to protect a plan beneficiary by not allowing the beneficiary to divest a legal right to receive benefit. A fraudulent transfer claim does not affect a beneficiary’s legal right. Therefore, the anti-alienation provision does not block a fraudulent transfer avoiding power action. Wagner v. Galbreth, 500 B.R. 42 (D.N. Mex. 2013). 3. BANKRUPTCY RULES 4. CASE COMMENCEMENT AND ELIGIBILITY 4.1 Eligibility 4.1.a. Chapter 7 debtor automatically loses sole manager rights of an LLC and may not authorize LLC petition. An individual chapter 7 debtor was the sole member and manager of an LLC. The trustee did not take any action to assert control over or administer the LLC or to change the manager. The debtor authorized a chapter 11 petition on behalf of the LLC. State law characterizes all of a member’s LLC interests as property but limits a levying creditor to execution on the profits of the LLC, not to the member’s management interests. Section 541(a) includes as property of the estate all of the debtor’s legal and equitable interests in property, not limited to the property on which a creditor may levy. Section 541 preempts any state law that would limit transferability of the debtor’s interest in property. Therefore, the debtor’s chapter 7 trustee automatically steps into the debtor’s shoes with respect to the LLC. The trustee need not assert control or replace the LLC’s manager. Therefore, the debtor did not have authority to file the LLC petition on behalf of the LLC, and the court dismisses the case. In re B & M Land and Livestock, LLC, 498 B.R. 262 (Bankr. D. Nev. 2013). 4.1.b. Court determines city’s desire to effect a plan and its good faith only on objective facts and actions. Before bankruptcy, the municipal debtor took some steps to reduce its losses and sell assets to raise cash, but its financial records were in disarray, and as a result, the debtor unexpectedly confronted a $45 million cash deficit for the coming fiscal year. It quickly filed a chapter 9 petition without formulating a proposed debt adjustment plan or a plan to pay postpetition expenses and without any meaningful negotiations with its creditors. But shortly before and after the filing, the debtor prepared a budget report and presented it to city council, held open public meetings about the financing reports and the debtor’s financial future, prepared an emergency fiscal plan and adopted it. To be eligible to proceed in chapter 9, a debtor must desire to effect a plan and must file its petition in good faith. A “desire” to effect a plan is the same as an intent to do so. Good faith requires that the city not use chapter 9 simply to buy time or evade creditors. Good faith is based on the totality of the circumstances. Although these factors are subjective, the court may determine their existence based only on objective facts, measured by the debtor’s acts, not by a subjective inquiry into the state of mind of the debtor’s officers or employees or a debtor’s qualification statement filed with the court. The city’s action in addressing its fiscal crisis showed its desire to effect a plan and its good faith. Therefore, the court issues the order for relief. In re City of San Bernardino, Calif., 499 B.R. 776 (Bankr. C.D. Cal. 2013). 4.2 Involuntary Petitions 4.3 Dismissal 5 5. CHAPTER 11 5.1 Officers and Administration 5.1.a. Section 1113 rejection does not relieve a debtor in possession from retiree benefits. The debtor had entered into a collective bargaining agreement that required it to pay retiree health benefits. After bankruptcy, the debtor in possession rejected the agreement under section 1113, relieving it of any further contractual obligations to the retirees. However, section 1114 requires a debtor in possession to continue to pay retiree benefits after bankruptcy until the court orders otherwise. The obligations morph from contractual to statutory, so the rejection of the collective bargaining agreement does not by itself relieve the debtor in possession from paying retiree benefits. Patriot Coal Corp. v. Peabody Holding Co. (In re Patriot Coal Corp.), 497 B.R. 36 (8th Cir. B.A.P. 2013). 5.1.b. Plan may not provide for insider severance contrary to section 503(c). Section 503(c) provides that a severance payment “shall neither be allowed, nor paid” to an insider unless it complies with certain limitations. The chapter 11 plan provided for a noncompliant severance payment to the CEO, who was to become the nonexecutive chairman of the reorganized debtor. Section 1123(b)(6) permits a plan to contain any provision not inconsistent with chapter 11; section 1129(a)(4) imposes a confirmation requirement that any payments to be made for services in connection with the case or in connection with the plan are disclosed and reasonable. Because section 503(c) prohibits payment of noncompliant severance, payment would be inconsistent with chapter 11 and would violate section 1123(b)(6), despite section 1129(a)(4)’s recognition that some plan-connected payments are permissible. Therefore, the plan may not provide for the payment. In re AMR Corp., 497 B.R. 691 (Bankr. S.D.N.Y. 2013). 5.1.c. Indenture “no action” clause is enforceable in a bankruptcy case. The debtor issued insured notes. The financing documents delegated all enforcement rights to the insurer, including control of enforcement rights and remedies and giving instructions to the collateral agent, and prohibited the noteholders from instituting or directing enforcement proceedings. Section 1109(b) grants every party in interest the right to be heard in a bankruptcy case. However, a “no action” clause is enforceable under applicable nonbankruptcy law. Although a no action clause is strictly construed, and this clause does not specifically mention action in a bankruptcy case, it is sufficiently broad to cover any enforcement action, even in a bankruptcy case. Therefore, the noteholders do not have standing to appear and be heard in the case. In re Am. Roads LLC, 496 B.R. 727 (Bankr. S.D.N.Y. 2013). 5.2 Exclusivity 5.2.a. Court sanctions creditor for filing draft plan as exhibit to motion to terminate exclusivity. During the debtor’s exclusivity period, the debtor’s principal secured creditor filed a motion to terminate exclusivity and attached as an exhibit to the motion a draft proposed plan that it would file if the court terminated exclusivity. The court denied the motion. The debtor sought attorneys’ fees from the creditor and subordination of the creditor’s claim for violating the debtor’s exclusive right to file a plan. Section 1121 gives a debtor the exclusive right to file a plan for a limited period. During that period, a creditor may not file a plan. Attaching a draft plan to a motion constitutes filing of the plan, as it is a public document on the court’s docket and available for viewing by creditors. The debtor need not show harm to its own plan process from the creditor’s action. Any burden rests with the filing creditor to show that other creditors did not review the draft plan. As a remedy, the court orders the creditor to pay the debtor’s attorneys fees for responding to the exclusivity motion, prohibits the creditor from filing any other plan, and requires the creditor to fund the cost of an examiner up to $50,000 from any recovery the creditor receives in the case. In re Charles St. African Methodist Episcopal Church of Boston, 499 B.R. 126 (Bankr. D. Mass. 2013). 5.3 Classification 5.4 Disclosure Statements and Voting 5.5 Confirmation, Absolute Priority 6 5.5.a. Plan preemption of state law may overcome impediment to feasibility. Before bankruptcy, the debtor self-insured its workers compensation liability. Applicable state law required the debtor to post cash, a letter of credit or a surety bond to assure claim payments. The debtor did all three. After bankruptcy, the state agency and the surety drew the letters of credit and with the cash the debtor had posted, created a fund for payment of claims. State law permitted turnover of such a claim fund to the debtor only after all claims had been resolved and paid. The debtor’s plan provided for immediate turnover of the claim fund to the estate to create a workers compensation claims escrow in an amount equal to the amounts of all undisputed claims plus the amount of the bankruptcy court’s estimation of disputed claim; state court adjudication of disputed claims, which would be paid in full from the escrow; prompt transfer of the excess of the claim fund over the escrow amount to the estate for distribution to creditors; and an injunction that channeled all workers compensation claims to the escrow. Section 1123(a)(5) requires a plan to provide adequate means for its implementation, notwithstanding any otherwise applicable bankruptcy law. Section 1129(a)(11) permits confirmation only if confirmation is not likely to be followed by liquidation or the need for further financial reorganization. If the debtor could not require turnover to the escrow of the claim fund, the plan would not meet section 1129(a)(11)’s feasibility requirement. If section 1123(a)(5) allows preemption of state workers compensation law and thereby permits turnover to the escrow of the claim fund, the plan would be feasible. A plan meets the feasibility requirement where preemption upon confirmation overcomes the impediment to feasibility. Irving Tanning Co. v. Maine Superint. of Ins. (In re Irving Tanning Co.), 496 B.R. 644 (1st Cir. B.A.P. 2013). 5.5.b. Section 1129(a)(3) does not bar confirmation of a plan that contains provisions prohibited by law. Before bankruptcy, the debtor self-insured its workers compensation liability. Applicable state law required the debtor to post cash, a letter of credit or a surety bond to assure claim payments. The debtor did all three. After bankruptcy, the state agency and the surety drew the letters of credit and with the cash the debtor had posted, created a fund for payment of claims. State law permitted turnover of such a claim fund to the debtor only after all claims had been resolved and paid. The debtor’s plan provided for immediate turnover of the claim fund to the estate to create a workers compensation claims escrow in an amount equal to the amounts of all undisputed claims plus the amount of the bankruptcy court’s estimation of disputed claim; state court adjudication of disputed claims, which would be paid in full from the escrow; prompt transfer of the excess of the claim fund over the escrow amount to the estate for distribution to creditors; and an injunction that channeled all workers compensation claims to the escrow. Section 1123(a)(5) requires a plan to provide adequate means for its implementation, notwithstanding any otherwise applicable bankruptcy law. Section 1129(a)(3) denies confirmation to a plan unless it is “proposed in good faith and not by any means forbidden by law.” Section 1129(a)(3) does not undo section 1123(a)(5)’s preemption authorization. It applies to only the means by which the plan is proposed and does not require that the plan comply with law that another Bankruptcy Code provision preempts. Therefore, section 1129(a)(3) does not prevent confirmation of a plan that relies on section 1123(a)(5) preemption of state law prohibiting an action the plan requires. Irving Tanning Co. v. Maine Superint. of Ins. (In re Irving Tanning Co.), 496 B.R. 644 (1st Cir. B.A.P. 2013). 5.5.c. Preemption for plan implementation under section 1123(a)(5) is limited to protect public health and safety and property rights. Before bankruptcy, the debtor self-insured its workers compensation liability. Applicable state law required the debtor to post cash, a letter of credit or a surety bond to assure payments of claims. The debtor did all three. After bankruptcy, the state agency and the surety drew the letters of credit and with the cash the debtor had posted, created a fund for payment of claims. State law permitted turnover of the claim fund to the debtor only after all claims had been resolved and paid. The debtor’s plan provided for immediate turnover of the claim fund to the estate to create a workers compensation claims escrow in an amount equal to the amounts of all undisputed claims plus the amount of the bankruptcy court’s estimation of disputed claim; state court adjudication of disputed claims, which would be paid in full from the escrow; prompt transfer of the excess of the claim fund over the escrow amount to the estate for distribution to creditors; and an injunction that channeled all workers compensation claims to the escrow. Section 1123(a)(5) requires a plan to provide adequate means for its implementation, notwithstanding any otherwise applicable nonbankruptcy law. It permits a plan provision, rather than federal law, to preempt state law. Therefore, courts construe section 1123(a)(5) preemption carefully, subject to three limitations. The plan provision must be adequate for the plan’s implementation, necessary, and nothing more. A law protecting public health, safety and welfare is not preempted. For both statutory and constitutional reasons, a law defining and protecting property rights is not preempted. Here, 7 the turnover of the claims fund is not necessary to a liquidating plan, workers compensation laws protect public health and safety, and turnover would violate the property rights of the claim fund owners. Therefore, the plan turnover provision does not preempt state law, and the court denies confirmation. Irving Tanning Co. v. Maine Superint. of Ins. (In re Irving Tanning Co.), 496 B.R. 644 (1st Cir. B.A.P. 2013). 6. CLAIMS AND PRIORITIES 6.1 Claims 6.1.a. Silent secured creditor’s lien rides through chapter 11 case. The chapter 11 debtor scheduled the secured creditor’s claim and lien as disputed and gave the creditor notice of the case filing and plan confirmation. The plan provided that the lien was discharged. The creditor did not file a proof of claim, appear in the case or object to confirmation. Section 1141(c) provides that after confirmation, “the property dealt with by the plan is free and clear of all claims and interests of creditors.” The courts have conditioned this section’s application on the lien holder’s participation in the case, on the ground, based in part on section 506(d), that a secured creditor who is satisfied to rely on the collateral alone may ignore the bankruptcy case and preserve the lien securing the claim. Participation means active participation. Receipt of notice does not constitute participation, such as appearing or filing a claim or objecting. Here, the secured creditor took no action at all. Therefore, section 1141(c) did not affect this lien, which was preserved. Acceptance Loan Co., Inc. v. S. White Trans., Inc. (In re S. White Transp., Inc.), 725 F.3d 494 (5th Cir. 2013). 6.1.b. Section 502(d) disallowance applies to a purchased claim. A trade creditor sold its claim. The debtor’s statement of affairs listed the trade creditor as having received a preference. The trustee objected to the claim under section 502(d) on the ground that the creditor had received a preference and had not returned it. Section 502(d) requires the court to disallow “any claim of any entity from which property is recoverable” under the avoiding powers unless “such entity has paid the amount … for which such entity or transferee is liable.” By its terms, the statute focuses on the claim, not the claimant, and requires disallowance no matter who holds the claim. That result is consistent with the bankruptcy policies of equal treatment, augmenting the estate and ensuring compliance with bankruptcy court orders and prevents the creditor from “washing” the claim through a sale. The purchaser is a volunteer in the bankruptcy process who can mitigate this risk through the purchase terms and therefore deserves no special protection. In re KB Toys, Inc., 736 F.3d 247 (3d Cir. 2013). 6.1.c. Trustee may file proofs of claim for creditors, even if doing so would not benefit the debtor. After the debtor joined a class action of which he was unaware during his bankruptcy and secured a recovery, the court reopened his formerly no-asset case and set a new claims bar date. When only one creditor filed a proof of claim, the trustee filed claims on behalf of all unsecured creditors listed in the debtor’s schedules. Section 501(c) permits a trustee to file a claim on behalf of a creditor who does not timely file a claim. The legislative history states that the provision was intended to benefit the debtor, not the creditors who failed to file claims. The provision is unambiguous, and the court may not override it based on legislative history. Therefore, the court permits the trustee to file the claims, subject to the debtor’s objections on the merits. Yoon v. VanCleef, 498 B.R. 864 (N.D. Ind. 2013). 6.2 Priorities 6.2.a. Contempt sanctions for postpetition environmental violations are entitled to administrative expense priority. Before bankruptcy, the state obtained a state court injunction requiring the debtor to bring facilities into compliance with environmental laws. The state brought a contempt motion in the state court, claiming the debtor had not complied with the injunction. While the contempt motion was pending, the debtor filed a chapter 11 case and continued operations. The state court stayed proceedings, but the bankruptcy court ruled that the automatic stay did not apply. The state court then issued a contempt citation and imposed a daily fine pending compliance. The debtor in possession did not comply, and the state requested assessment of the penalties, which the state court granted. Section 503(b) grants administrative expense priority to the actual and necessary costs and expenses of preserving the estate. Reading Co. v. Brown, 391 U.S. 471 (1968), granted administrative expense priority to a tort claim resulting from the estate’s business operation. Here, although state court issued the 8 initial compliance order before bankruptcy, it imposed contempt sanctions for postpetition noncompliance. Therefore, the sanctions qualify as an administrative expense, whether compensatory or punitive, as long as they were incurred in the postpetition business operation. Munce's Superior Petroleum Prods., Inc. v. N.H. Dept. of Enviro. Servs., 736 F.3d 567 (1st Cir. 2013). 6.2.b. Section 510(b) subordinates claim for debtor’s failure to issue additional stock. The debtor used its own stock to purchase stock of the seller’s subsidiary. The agreement provided that the debtor would issue more of its stock to the seller if the debtor’s the stock price declined. The agreement also required the debtor to assume the subsidiary’s real property leases. The debtor did not assume the leases, its stock price declined, and the debtor filed bankruptcy. Section 510(b) subordinates a claim for “damages arising from the purchase or sale of a” security of the debtor. Damages arise from the purchase or sale when they originate from the purchase or sale and are causally connected to the purchase or sale. Section 510(b) does not distinguish between fraud claims and breach of contract claims. It prevents a party who has bargained for the upside of being a shareholder from converting to creditor status on the downside. Here, the seller’s claim arising from the debtor’s obligation to issue more shares is a claim arising from the debtor’s sale of its securities and so is directly within section 510(b). The seller’s right to more shares gave the seller the risks and rewards of a stockholder, not of a creditor. Therefore, section 510(b) subordinates the claim for nondelivery of the additional shares. However, the seller did not take equity risk and rewards in connection with the debtor’s agreement to assume the subsidiary’s leases. It was collateral to the purchase and sale of the debtor’s stock. Therefore, section 510(b) does not subordinate that claim. KIT Digital, Inc. v. Invigor Group Ltd. (In re KIT Digital, Inc.), 497 B.R. 170 (Bankr. S.D.N.Y. 2013). 6.2.c. Electricity is not “goods.” A municipal lighting plant supplied the debtor with electricity. After bankruptcy, the plant asserted an administrative expense priority claim for electricity supplied within 20 days before bankruptcy. Section 503(b)(9) grants an administrative expense priority to a claim of a supplier for goods received by the debtor within 20 days before bankruptcy and sold to the debtor in the ordinary course of business. Courts should look to U.C.C. Article 2 for a definition of “goods”. U.C.C. § 2-105(1) defines “goods” as “all things … which are movable at the time of identification to the contract for sale.” Electricity becomes identifiable to the contract when it passes through the meter at the buyer’s location. The buyer uses the electricity an infinitesimal period later. The electricity moves between the meter and consumption point and is therefore in some sense “movable,” but the infinitesimal period is not a meaningful period that makes the electricity movable in any practical sense. Moreover, electricity cannot be stored, and It cannot be reclaimed, so it is not eligible for reclamation under section 546(c), which should be read in conjunction with section 503(b)(9), as they were added to the Bankruptcy Code at the same time. For these reasons, among others, electricity is not “goods,” and the supplier is not entitled to an administrative priority claim under section 503(b)(9). In re NE Opco, Inc., 501 B.R. 233 (Bankr. D. Del. 2013). Accord In re PMC Marketing Corp., 501 B.R. 17 (Bankr. D.P.R. 2013). 7. CRIMES 8. DISCHARGE 8.1 General 8.2 Third-Party Releases 8.3 Environmental and Mass Tort Liabilities 9 9. EXECUTORY CONTRACTS 9.1.a. Trustee may draw letter of credit under which the debtor is the beneficiary. The debtor contracted with an engineering firm to construct a plant. The firm arranged for a bank to issue a letter of credit to the debtor to secure the firm’s performance. The debtor did not draw the letter of credit before bankruptcy. The trustee sued the debtor’s attorney for malpractice for failing to advise the debtor to draw the letter of credit before bankruptcy, arguing that section 365(c)(2) prohibited a postpetition draw. Section 365(c)(2) prohibits a trustee from assuming “any executory contract … of the debtor … to make a loan, or extend other debt financing or financial accommodations, to or for the benefit of the debtor.” The independence principle governs a letter of credit. Each of the three relationships—between the applicant and the issuer, the issuer and the beneficiary, and the beneficiary and the applicant—is independent of the other. The relationship between the issuer and the beneficiary is not a contract, because there are no mutual obligations; the beneficiary may but is not required to give notice of draw. Even if it were a contract, it is not an executory contract, because the beneficiary cannot breach any obligation that would relieve the issuer from its obligation to the beneficiary. And a letter of credit under which the debtor is the beneficiary is not a contract to make a loan, extend debt financing or financial accommodation to the debtor. These terms describe a relationship of granting credit to the debtor; section 365(c)(2)’s purpose is to protect a lender from the debtor’s deteriorated creditworthiness. Therefore, the letter of credit is not an executory contract of the debtor to extend financial accommodations to or for the benefit of the debtor. The benefit of the letter of credit passes to the estate, which may draw. So the debtor’s attorney did not commit malpractice by failing to advise the debtor to draw before bankruptcy. Rafool v. Evans, 497 B.R. 312 (C.D. Ill. 2013). 9.1.b. Section 365(d)(4) applies only to a lease under which the debtor is in possession. The first debtor assumed and assigned the lease to an affiliate debtor, which assigned the lease to a third debtor, before its bankruptcy. After the assignment, the second debtor filed bankruptcy again. The court determined that it retained payment obligations to the landlord under the lease, which the second debtor then rejected. Later, the third debtor filed bankruptcy. It moved to assume the lease. Section 365(a) permits the debtor in possession to assume or reject an executory contract or unexpired lease. Section 365(d)(4) automatically rejects a nonresidential real property lease under which the debtor is the lessee if it is not timely assumed and then requires the debtor in possession to surrender possession to the landlord. A lessee is one in possession of real property under a lease. Section 365(d)(4) requires surrender of possession, confirming that it applies to one who is in possession. A lease assignment divests the assignor of any further interest in the leasehold and creates privity of estate between the landlord and the assignee. Rejection is only a breach, not a termination or rescission. Here, the second debtor was not the lessee, because it had assigned its leasehold to the third debtor and was no longer in possession of the real property. Therefore, section 365(d)(4) did not apply in the second debtor’s bankruptcy case, so the rejection did not terminate or rescind the lease. The third debtor was the lessee and was entitled to assume the lease in its bankruptcy case. John Hilsman Invs., LLC v. Quality Props., LLC, 500 B.R. 105 (N.D. Ala. 2013). 9.1.c. Section 560 safe harbor protects liquidation methodology. The debtor entered into an interest rate swap agreement that permitted the counterparty to determine the termination amount upon a default under one method for most defaults and a different method if the debtor’s default was nonpayment or bankruptcy. Section 365(e) renders unenforceable a contract provision that is triggered by the debtor’s bankruptcy. However, section 560 provides that “the exercise of a contractual right to … to cause the liquidation, termination, or acceleration of [a] swap agreement … shall not be stayed, avoided, or otherwise limited by operation of any provision of this title.” As used in section 560, “liquidation” means fixing an otherwise uncertain amount. The choice of liquidation method is integral to liquidation, and the nondefaulting party’s use or a particular method is a contractual right that may not be limited by the Bankruptcy Code. The method is not ancillary to the contractual right, as is a “flip clause,” which changes priority rights in collateral upon a bankruptcy, distinguishing this case from Lehman Bros. Special Fin. Inc. v. Ballyrock ABS CDO 2007-1 Ltd., 452 B.R. 31 (Bankr. S.D.N.Y. 2011). Therefore, the counterparty may use the alternative calculation method. Mich. State Housing Devel. Auth. v. Lehman Bros. Derivative 10 Prods. Inc. (In re Lehman Bros. Holdings Inc.), ___ B.R. ___, 2013 Bankr. LEXIS 5317 (Bankr. S.D.N.Y Dec. 19, 2013). 10. INDIVIDUAL DEBTORS 10.1 Chapter 13 10.2 Dischargeability 10.3 Exemptions 10.4 Reaffirmation and Redemption 11. JURISDICTION AND POWERS OF THE COURT 11.1 Jurisdiction 11.1.a. Bankruptcy judge may not constitutionally determine core proceeding even with litigants’ consent. The debtor in possession sued a defendant in the bankruptcy court on state law non-core contract and tort claims, consenting to the bankruptcy court’s issuing final judgment. After unsuccessfully attempting to withdraw the consent and then losing the litigation in the bankruptcy court, the debtor in possession appealed, arguing that the bankruptcy court lacked constitutional authority to issue final judgment. Article III vests judicial power in judges whose tenure is during good behavior and whose salaries may not be reduced. Article III protects litigants’ personal interests in an independent judiciary but also, importantly, protects structural interests in the separation of powers. Bankruptcy judges are not Article III judges. Therefore, even though section 157(c)(2) permits a litigant to consent to a bankruptcy judge’s issuing a final judgment in a non-core proceeding, Article III’s structural protections prevent the court from constitutionally permitting it. However, because section 157(c)(2) expressly permits a bankruptcy judge to issue proposed findings and conclusions in a non-core proceeding, the court of appeals remands for that purpose. BP RE, L.P. v. RML Waxahachie Dodge, L.L.C. (In re BP RE, L.P.), 735 F.3d 279 (5th Cir. 2013). 11.1.b. Creditor may bring a proceeding under section 105. Three creditors brought fraudulent transfer actions in state court against a transferee. The defendant brought an action in the bankruptcy case to enjoin the creditors from pursuing their fraudulent transfer action on the ground that the fraudulent transfer actions are property of the estate. Section 105(a) authorizes the court to issue any order, process or judgment that is necessary to carry out the provisions of the Bankruptcy Code. Section 105(b) permits the court to act sua sponte. Section 105(a)’s literal language does not limit the court to acting only on motion of the trustee, and section 105(b) confirms that the court may act even if the trustee does not request action. Therefore, a creditor may seek an order under section 105(a) when the creditor’s rights are threatened and when necessary to carry out the provisions of the Bankruptcy Code. GTCR Golder Rauner, LLC v. Scharrer (In re Fundamental Long Term Care, Inc.), 501 B.R. 770 (Bankr. M.D. Fla. 2013). 11.2 Sanctions 11.3 Appeals 11.3.a. Court dismisses as moot a chapter 9 confirmation order appeal challenging debtor’s constitutional authority. The county controlled the county hospital board. The county council replaced the hospital board members with the council board members and later filed a chapter 9 case for the hospital. A displaced hospital board member sued, arguing that the replacement violated a state constitutional prohibition on dual office holding. While the bankruptcy case was pending, the state supreme court ruled in favor of the former board member. The former board member moved to dismiss the bankruptcy case as improperly authorized and objected to the debtor’s plan to sell the hospital. The bankruptcy court denied the motion, overruled the confirmation objection and confirmed the plan. The 11 former board member sought a stay from the bankruptcy court, which was denied. The hospital and the buyer consummated the sale and disbursed the sale proceeds to creditors. The former board member appealed. When deciding a motion to dismiss an appeal from a confirmation order as equitably moot, a court should consider whether the appellant sought a stay, whether the plan has been substantially consummated and the extent to which the appellate relief requested would affect the reorganization’s success and third parties’ interests. Here, the appellant sought a stay only from the bankruptcy court, the plan was substantially consummated and granting appellate relief would undo the plan completely and unduly harm innocent third parties who are not before the court. Therefore, the court dismisses the appeal as moot. Alexander v. Barnwell County Hospital, 498 B.R. 550 (D.S.C. 2013). 11.4 Sovereign Immunity 12. PROPERTY OF THE ESTATE 12.1 Property of the Estate 12.1.a. A right to appeal a judgment defensively is property of the estate. A creditor obtained a sanctions judgment against the debtor before bankruptcy. The debtor appealed and later filed bankruptcy. The trustee proposed to sell the debtor’s right to appeal as property of the estate. Section 541(a) looks first to state law to determine what is property, then to federal law to determine if it is property of the estate. State law here defines property as every species of valuable right and interest. The right to request a higher court to review a lower court’s judgment and reduce claims against the debtor and its property is a valuable right that could be used to reduce a claim against the estate. Therefore, it is property of the estate that the trustee may sell. Croft v. Lowry (In re Croft), 737 F.3d 372 (5th Cir. 2013). 12.1.b. Property of the estate includes the debtor’s management authority over an LLC, despite contrary state law. The debtor was a managing member of a Virginia LLC. The debtor filed a chapter 13 petition, which was dismissed 22 days later. Virginia law provides that an LLC interest is personal property and that upon an LLC member’s bankruptcy, the member retains the economic interest but loses any management authority over the LLC. Nevertheless, while the case was pending, the debtor authorized the LLC to file a bankruptcy. After the chapter 13 case was dismissed, the debtor and the other managers ratified the prior managers’ action in authorizing the LLC filing and re-authorized it. Section 541(a) includes in property of the estate all of the debtor’s interests in property as of the commencement of the case. Section 541(c) overrides any nonbankruptcy law restriction on transfer of property to the estate. Therefore, despite the debtor’s chapter 13 filing, his entire LLC interest, including his management authority, became property of the estate. Section 349(b)(3) provides that upon dismissal of a case, property of the estate revests in the entity in whom it was vested as of the commencement of the case. Its effect is to undo all of the effects of the filing and to restore, to the extent possible, property to the position in which it was held at the commencement of the case. Here, the dismissal revested the entire LLC interest in the debtor, who was then fully authorized to exercise management authority and to ratify the managers’ prior actions. Therefore, the LLC petition was properly authorized. Official Committee of Unsecured Creditors v. In re Virginia Broadband, LLC (In re Virginia Broadband, LLC), 498 B.R. 90 (Bankr. W.D. Va. 2013). 12.1.c. Provisional credit funds on an uncollected check are property of the debtor. The debtor title company received a check for its client trust account from a fraudulent borrower to pay a loan. The debtor deposited the check with its bank, which issued a provisional credit to the debtor. The debtor issued payment to the lender based on the provisional credit. The check bounced, and the bank charged back the debtor’s trust bank account. The chargeback depleted all the debtor’s funds, rendering it insolvent, and resulting in its bankruptcy. The trust account had other funds at the time of the chargeback, which remained at the time of bankruptcy. The funds included other clients’ trust funds and fees owed to the debtor. The estate sued the lender to recover the entire payment as a fraudulent transfer. The estate may avoid and recover a transfer of property of the debtor made without receiving reasonably equivalent value in exchange if the transfer left the debtor with unreasonably small capital. The transfer here clearly left the debtor with unreasonably small capital, and the debtor did not receive reasonably equivalent value by payment of the lender’s claim, because only the borrower, not the debtor, had an obligation to the 12 lender. The trust account portion representing fees owed to the debtor was property of the debtor, and the other clients’ trust funds were held in trust and not property of the debtor. A trust is created upon an express declaration of trust and conveyance of and vesting of title to property in the trustee. Because the check bounced, the borrower never conveyed property to the debtor, and the bank did not intend to create a trust. So the debtor did not hold the provisional credit funds in trust. Under U.C.C. § 4-210, the bank has a security interest in the check (an item) and its proceeds. The check self-liquidated upon collection of the check. Proceeds includes whatever is acquired upon sale or other disposition of collateral. The bank’s provisional credit to the debtor was not proceeds of the check. Therefore, the bank did not have a security interest in the provisional credit funds in the trust account, and the funds were unencumbered property of the debtor. As a result, the debtor’s transfer to the lender was a fraudulent transfer that the estate could avoid and recover. The White Families Cos. v. Slone (In re Dayton Title Agency, Inc.), 724 F.3d 675 (6th Cir. 2013). 12.2 Turnover 12.3 Sales 13. TRUSTEES, COMMITTEES, AND PROFESSIONALS 13.1 Trustees 13.1.a. Section 108(a) statute of limitations extension applies to a liquidating trustee. The estate had a malpractice claim against the debtor’s counsel. The claim’s statute of limitations expired within two years after bankruptcy. The debtor confirmed a plan that vested the claim in a liquidating trust under section 1123(b)(3)(B) as a representative of the estate for the benefit of two classes that did not receive any other distribution under the plan. The liquidating trustee brought the claim within two years after bankruptcy but after the state law statute of limitations expired. Section 108(a) permits the trustee to bring an action within two years after the order for relief, despite any shorted nonbankruptcy statute of limitation, if that statute has not expired as of the date of the filing of the petition. The liquidating trust is a successor to the trustee and therefore succeeds to any rights that the trustee had. Therefore, section 108(a) applies to a liquidating trustee. Antioch Litigation Trust v. McDermott Will & Emery LLP, 500 B.R. 755 (S.D. Ohio 2013). 13.1.b. SLUSA may bar a trustee’s action as assignee of creditors’ claims. The trustee received assignments of creditors’ claims against third parties who might have had liability to creditors (but not to the debtor, because of the in pari delicto doctrine) and brought an action against the third parties. The action included a claim that would be a “covered class action” claim under the Securities Litigation Uniform Standards Act of 1998 (SLUSA), 15 U.S.C. § 78bb, that is, a claim alleging “a misrepresentation or omission of a material fact in connection with the purchase or sale of a security” in an action in which “damages are sought on behalf of more than 50 persons or prospective class members, and questions of law or fact common to those persons or members of the prospective class, without reference to issues of individualized reliance on an alleged misstatement or omission, predominate over any questions affecting only individual persons or members.” A bankruptcy trustee’s claim that is property of the estate is not a covered class action. Even though the action is for the benefit of numerous creditors, the trustee is a single entity, succeeding to a single entity’s claim. However, where the trustee takes assignments of claims, he stands in the multiple assignors’ shoes and therefore the number of assignors must be counted in determining whether the action is a covered class action. Securities Inv. Protec. Corp. v. Bernard L. Madoff Inv. Secs. LLC (In re Bernard L. Madoff Inv. Secs. LLC), 2013 U.S. Dist. LEXIS 172638 (S.D.N.Y. Dec. 6, 2013). 13.1.c. Court may terminate trustee’s appointment when circumstances that led to appointment no longer exist. The debtor electric cooperative’s board deadlocked and agreed to the appointment of a trustee. Eventually, the board members agreed on a course of action. Section 1105 permits the court to terminate a trustee’s appointment and restore the debtor to possession and management of the estate and business. Section 1105 does not specify any standards to guide the court’s discretion. Here, the court concludes that the circumstances that prompted the trustee’s appointment—a deadlocked board—no 13 longer existed and so terminated the trustee’s appointment. In re Southern Mont. Elec. Gen. & Trans. Coop., Inc., ___ B.R. ___, 2013 Bankr. LEXIS 5009 (Bankr. D. Mont. Nov. 26, 2013). 13.2 Attorneys 13.2.a. Bankruptcy court may consider only section 330(a)(3) factors in awarding attorneys fees. Before bankruptcy, an attorney agreed to represent the debtor for half the attorney’s normal hourly rate and 15% of the recovery to pursue a risky claim against a third party. After bankruptcy, the court authorized the debtor in possession to employ the attorney with fees to be determined by the court under section 330. The attorney spent only 43 hours and produced a settlement with a recovery to the estate of at least $2.25 million more than could have been expected before the commencement of litigation, based on the attorney’s creative strategy. Creditors were paid in full, and the debtor received a surplus. The bankruptcy court awarded a fee based on the prepetition agreement, based in part on the big risk the attorney took and the big reward. Section 330(a)(3) permits the court to award a fee based on (A) the time spent, (B), the rates charged, (C) necessity or benefit, (D) whether the services were performed within a reasonable time, (E) the attorney’s skill and experience in bankruptcy, and (F) reasonableness, based on customary compensation. The Tenth Circuit applies the adjusted lodestar approach, which takes into account the factors under section 330(a)(3) and the 12 factors set forth in Johnson v. Ga. Highway Express, Inc., 488 F.2d 714 (5th Cir. 1974), including time and labor, novelty and difficulty, required skill, customary fee, whether the fee is contingent, amount involved, results obtained and awards in similar cases. The lodestar subsumes four Johnson factors (novelty and complexity, counsel’s skill, quality of the representation and results), so the court may make an adjustment based on results only in a rare and exceptional case. In Perdue v. Kenny A. ex rel. Winn, 130 S. Ct. 1662 (2010), the Supreme Court rejected use of the Johnson factors in cases involving fee shifting statutes and limited consideration to the lodestar. The Court of Appeals determines that standards in bankruptcy cases differ from those in feeshifting cases and so does not apply Perdue. The bankruptcy courts remain bound by section 330(a)(3) and relevant Johnson factors. Further, the bankruptcy courts must consider all the section 330(a) factors and no other factors, other than relevant Johnson factors. They may not consider “big risk/big reward” or the attorney’s prepetition compensation arrangement. Within those limitations, they have substantial discretion. But the fee here was based on impermissible factors, so the court of appeals reverses and remands for further consideration. Market Center E. Retail Prop., Inc. v. Lurie (In re Market Center E. Retail Prop., Inc.), 750 F.3d 1239 (10th Cir. 2013). 13.2.b. Section 329(b)’s remedy is limited to attorney compensation and does not encompass other transfers. The debtor filed a chapter 13 petition, which the court dismissed. The court then dismissed the debtor’s second chapter 13 petition three months later. The debtor’s attorney received an $1,800 fee for the first case and disclosed that he had received $12,000 in the second case. Three months after the court dismissed the second case, the court reopened the case and converted it to chapter 7. Between dismissal and reopening, the debtor was sentenced to life for a criminal conviction and transferred to his attorney real property that was subject to a lien. The attorney did not disclose the real property transfer to the court in a Rule 2016 statement. He later bought the property for $99,000 in cash at the lienor’s foreclosure sale. On the trustee’s motion, the bankruptcy court ordered return of the cash and real property compensation under section 329, without regard to the amount the attorney had paid to the lienor at the foreclosure sale. Section 329(a) requires an attorney to disclose compensation received in contemplation or in connection with the case. Section 329(b) permits the court to order a return of any compensation “to the extent excessive.” To do so, the court must determine the value of the services and, if the court imposes sanctions, must determine and justify the amount of the sanctions. By disregarding the amount the attorney paid to acquire the real property, the court effectively ordered the attorney to pay $99,000 to the estate. To justify such an order, the court had to evaluate the attorney’s conduct and state a reason for sanctions and for the amount of the sanctions. The court could not properly make a blanket “return” order without such an analysis. Baker v. Cage (In re Whitley), 737 F.3d 981 (5th Cir. 2013). 13.2.c. PACA trust may not pay attorneys fees before full payment of PACA claims. After bankruptcy, the debtor’s suppliers asserted trust fund claims under the Perishable Agricultural Commodities Act (PACA). The court issued a procedures order governing the filing, consideration and resolution of such claims, the collection of trust assets from the debtor’s customers and the employment of special counsel at the expense of the trust to carry out the order. Generally, a trustee may incur 14 expenses, payable from trust assets, to collect and preserve trust assets. However, PACA differs. It requires full payment of amounts owing to suppliers before any trust funds are used for any other purpose. Therefore, special counsel’s fee may not be paid from the PACA trust until all PACA suppliers are paid in full. Kingdom Fresh Produce v. Bexar County (In re Delta Produce, LP), 498 B.R. 731 (W.D. Tex. 2013). 13.3 Committees 13.3.a. Plan may provide for committee members’ attorneys’ fees. The chapter 11 plan provided for payment of creditors committee members’ attorneys fees. Section 503(b)(3)(F) allows as an administrative expense a creditors committee member’s expenses, other than professional fees, and section 503(b)(4) allows as an administrative expense the professional fees incurred by an entity whose expenses are allowed under section 503(b), except a committee member. Section 1123(b)(6) permits a plan to contain any provision not inconsistent with chapter 11; section 1129(a)(4) imposes a confirmation requirement that any payments to be made for services in connection with the case or in connection with the plan are disclosed and reasonable. Section 503(b)(4) does not prohibit payment of a committee member’s professional fees. It only denies the member the right to the fees’ allowance as an administrative expense. A committee is free to negotiate for the fees as a plan term, which is then subject to disclosure, creditor voting and reasonableness. Thus, the two chapter 11 sections permit a plan to provide for their payment. In re AMR Corp., 497 B.R. 691 (Bankr. S.D.N.Y. 2013). 13.3.b. Creditors committee acts under color of law for purpose of RFRA. The archbishop is the trustee of a trust that the debtor archdiocese maintains for the maintenance and care of cemeteries, which is central to the practice of the archdiocese’s religion. Acting on behalf of the debtor in possession as representative of the estate, the creditors committee sought to invade the trust corpus to pay claims against the archdiocese. The federal Religious Freedom Restoration Act (RFRA) prohibits the government from substantially burdening a person’s exercise of religion. RFRA defines government as any person acting under color of law. A person acts under color of law if the action is fairly attributable to the government. An action is fairly attributable if it involves the “exercise of some right or privilege created by the [government] or by a rule of conduct imposed by the [government]” and the actor “may fairly be said to be a state actor.” A debtor in possession is an officer of the court. A creditors committee is entitled to the same quasi-judicial immunity that a trustee in bankruptcy enjoys for actions within the scope of the committee’s statutory duties and powers. Therefore, the committee acts under color of law, and its actions are government actions under RFRA. Listecki v. Official Committee of Creditors (In re Archdiocese of Milwaukee), 496 B.R. 905 (E.D.Wis. 2013). 13.4 Other Professionals 13.4.a. Firm’s sharing of compensation with regular contract executive does not violate section 504 but does require a separate conflicts check and disclosure. The debtor in possession employed a turnaround management firm. The lead turnaround manager from the firm on the assignment was actually a contractor to the firm through his wholly-owned single member LLC, though he had the title of Executive Director with the firm. His contract provided that he would work exclusively for the firm and would be paid a fixed monthly amount plus 80% of the fees that he generated on this case plus an incentive payment related to the fees from this case. The firm charged the estate hourly fees. During the engagement, the firm and the lead manager amended his contract to permit him to seek assignments that might compete with the firm. The firm submitted a statement of disinterestedness under Bankruptcy Rule 2014 but had not run separate conflicts checks on the lead manager’s connections. Section 504 prohibits a professional employed at the expense of the estate from sharing compensation with any other person, except that members, partners and regular associates of firms may share compensation among themselves. Whether a professional qualifies under the exception is based on a functional analysis rather than on the professional’s title with the firm. Bankruptcy Rule 2016(a) requires that a fee application disclose any sharing agreement or understanding, “except that the details of any agreement by the applicant for the sharing of compensation as a member or regular associate of a firm of lawyers or accountants shall not be required.” One of the disclosure’s purposes is to require separate retentions, ensure disclosure of the contractor’s connections that might show conflicts and thereby to leave decisions about retention with the bankruptcy court, rather than with the firm. Because the lead manager was acting as part of the firm, even though only under a contract with his single member LLC, he should be considered a regular associate or member of the firm. Still, Rule 2016(a) requires disclosure of the relationship, and Rule 2014 requires disclosure of any of the lead manager’s connections, in addition to 15 the firm’s connections, with parties in interest in the case. Therefore, the firm’s use of the lead manager in this case was proper, but its disclosure and its conflicts checks were inadequate. The court reduces the firm’s and the lead manager’s compensation as sanctions for the violations. In re GSC Group, Inc., 502 B.R. 673 (Bankr. S.D.N.Y. 2013). 13.5 United States Trustees 14. TAXES 15. CHAPTER 15—CROSS-BORDER INSOLVENCIES 15.1.a. Section 109(a) applies to limit chapter 15 eligibility. The foreign representatives sought recognition under chapter 15 to take discovery in the U.S. against directors of an investor in the foreign debtor. The foreign debtor did not have a residence, domicile, place of business or assets in the United States. Section 109(a) requires, “Notwithstanding any other provision of this section, only a person that resides or has a domicile, a place or business, or property in the United States … may be a debtor under this title.” Section 103(a) makes chapter 1 applicable in a chapter 15 case. Nothing in chapter 15 excludes section 109(a). Therefore, a court may not grant recognition to a foreign representative for a debtor that is not eligible under section 109(a). Drawbridge Spec. Opp. Fund LP v. Barnet (In re Barnet), 737 F.3d 238 (2d Cir. 2013). 15.1.b. Section 1517 recognition requirements do not permit reexamination of the foreign court’s judgment. The debtor was an Irish citizen who had resided the in the Cayman Islands for 20 years. The Commonwealth of the Northern Marianas asserted substantial tax claims against him and had obtained default judgments for the taxes, which the debtor disputed. He filed a bankruptcy petition in the Cayman court, which approved the petition and ordered that the proceeding continue there, in part to obtain a stay on the tax cases while he could pursue relief. The foreign representative sought recognition of the Cayman proceeding in the United States under chapter 15 as a foreign main proceeding. Section 1517 requires recognition as a foreign main proceeding of a proceeding in a foreign country under a law relating to insolvency or debt adjustment that is pending in the country where the debtor has his center of main interests. The statutory requirements dictate whether the court grants recognition, based on the nature of the foreign proceeding, not on the U.S. court’s determination of whether the foreign debtor properly qualified under the foreign proceeding. Because the Cayman court found the debtor eligible for a Cayman bankruptcy proceeding, the court grants recognition. A court may refuse recognition if recognition would be manifestly contrary to the public policy of the United States. Courts must construe the exception narrowly. The debtor’s ability to challenge a judgment without posting a bond is not contrary to U.S. public policy. Nor is a filing to stay enforcement pending challenge in bad faith. Even if it were, section 1517’s mandatory recognition requirement does not contain a bad faith exception. Therefore, the court grants recognition. In re Millard, 501 B.R. 645 (Bankr. S.D.N.Y. 2013). 15.1.c. Chapter 15 discovery order is appealable and brings up the recognition order for review. The foreign representatives sought recognition under chapter 15 to take discovery in the U.S. against directors of an investor in the foreign debtor. The court granted recognition of the foreign proceeding as a foreign main proceeding and then issued an order authorizing discovery. The directors appealed. Only a person aggrieved may appeal from a bankruptcy court order. The recognition order does not directly and adversely affect the directors, so they do not have standing to appeal from it. However, the discovery order does affect them pecuniarily, and because it permits discovery in aid of a foreign proceeding, rather than constituting a step in the chapter 15 case, is an appealable final order. The recognition order was a prerequisite to the discovery order. Therefore, an appeal from the discovery order brings up the recognition order for review. Drawbridge Spec. Opp. Fund LP v. Barnet (In re Barnet), 737 F.3d 238 (2d Cir. 2013). 15.1.d. Court applies section 365(n) in a chapter 15 case to prevent termination of technology licenses. The German debtor filed an insolvency proceeding in Germany. The German Insolvency Administrator obtained recognition under chapter 15 of the German proceeding as a foreign main 16 proceeding. In the German proceeding, the Insolvency Administrator elected nonperformance of the debtor’s intellectual property cross-license agreements with international technology companies that operated in the United States. Under German insolvency law, upon electing nonperformance, the Insolvency Administrator may prevent the licensees from using the licensed technology, contrary to the protection that section 365(n) gives licensees in a U.S. bankruptcy case. The U.S. licensees developed expensive factories that incorporated the licensed technology and could suffer major losses of sunk costs (although the court was unable to estimate how much the losses would be) or exposure to royalty demands if they did not receive protection in the chapter 15 case comparable to the protection that section 365(n) provides. Section 1509(b) requires a U.S. court, after recognition of a foreign proceeding, to grant comity and cooperation to the foreign representative. Section 1521(a) requires the court, upon request of the foreign representative, to grant “any appropriate relief,” subject to the debtor’s and creditors’ rights being “sufficiently protected.” The court may require application of section 365(n) to provide protection to creditors, even if the foreign representative does not specifically request its application. Section 1522(a)’s sufficient protection provision requires the court to balance the respective interests, based on relative harms and benefits, of the foreign representative and the creditors who would be affected by the order the foreign representative seeks, not just determine whether the requested relief leaves the creditors on an equal footing with other creditors. Here, the Insolvency Administrator would realize less (but some) value if section 365(n) applies, but section 365(n) would not impose any affirmative obligation on him. By contrast, the licensees could lose substantial value in existing investments, so they are not sufficiently protected without application of section 365(n). In addition, failure to apply section 365(n) could destabilize the pervasive technology cross-licensing regime. Therefore, the court applies section 365(n) and protects the licensees. Jaffé v. Samsung Electronics Co., 737 F.3d 14 (4th Cir. 2013).
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