Bankruptcy and Restructuring Blog

In a recently-issued Revenue Procedure (Rev. Proc. 2008-28), the IRS states that the modification of certain mortgage loans under foreclosure prevention programs involving, for example, interest rate reductions, principal forgiveness, extensions of maturity and alterations in the timing of changes in an interest rate generally will not cause the IRS either to challenge the tax status of certain securitization vehicles that hold the loans or to assert that those modifications create a liability for tax on a prohibited transaction. This relief is granted to real estate mortgage investment conduits (REMICs) and investment trusts where the mortgage loan meets all of the following conditions:

In the case of The HA2003 Liquidating Trust v. Credit Suisse Securities (USA) LLC, __ F.3d __ (7th Cir. 2008) ("HA2003"), HALO, an acquiring company, hired CSFB, an investment banker, to (i) renegotiate the economic terms of a stock acquisition of the dot-com target company, Starbelly.com, and (ii) issue a fairness opinion on behalf of HALO in connection with the acquisition.  Concluding that CSFB did not act grossly negligent in issuing the fairness opinion even though the fairness opinion was based on numbers known by HALO's management to be inaccurate, the Seventh Circuit refused to impose liability on CSFB for alleged damages suffered by HALO and its shareholders when HALO became insolvent and filed bankruptcy after the acquisition.

By Order, dated January 14, 2008, United States Bankruptcy Judge Martin Glenn for the United States Bankruptcy Court for the Southern District of New York, granted the motion (the "Motion") filed by a group of creditors seeking transfer of venue of the Dunmore Homes, Inc. (the "Debtor") bankruptcy case from the United States Bankruptcy Court for the Southern District of New York (the "Court") to the Eastern District of California, Sacramento Division.  A number of other creditors and the Official Unsecured Creditors Committee joined in the Motion.  The Motion was opposed by the Debtor, bondholders and two bank creditors.

On May 18, 2007, the Supreme Court for the State of Delaware (the "Court") held that a creditor of a corporation that is operating within the zone of insolvency may not bring a direct action against the corporation's directors for a breach of fiduciary duty under Delaware law.  The Court agreed with the lower court that (i) the creditors' existing protections, including negotiated agreements, security instruments, implied covenant of good faith and fair dealing, fraudulent conveyance law and bankruptcy law make an additional layer of protection in the form of a direct cause of action for breach of fiduciary duty unnecessary and (ii) allowing creditors a direct cause of action against the directors may undermine the corporation's ability to vigorously negotiate with its creditors at a time when the corporation may most need that ability.

On March 7, 2007, the Second Circuit Court of Appeals held that "in the Chapter 11 context, whether a pre-plan settlement's distribution plan complies with the Bankruptcy Code's priority scheme will be the most important factor for a Bankruptcy Court to Consider in approving a settlement under Bankruptcy Rule 9019."  In re Iridium Operating LLC, No. 05-2236 (2d Cir. March 7, 2007)

The defendants were purchasers of certain copyrights and other assets of debtors Luke Records, Inc. and Luther Campbell under a confirmed chapter 11 plan.  Prior to the filing of the debtors' bankruptcy cases, plaintiff Jeffrey J. Thompkins had conveyed his copyrights in sound recordings and musical compositions to the debtors in exchange for the payment of royalties.  This conveyance was embodied in agreements (the "Agreements") that provided for the "exclusive, unlimited and perpetual rights throughout the world" to the copyrights in sound recordings and musical compositions created by Thompkins, along with "an undivided 50% of the publishing interest" in all such compositions, in exchange for Thompkins' right to be paid royalties and, in some cases, for one-time cash advances.

In Enron Broadband Services, L.P. v. Travelers Casualty and Surety Company of America (In re Enron) 2006 WL 2456203 (Bankr.S.D.N.Y. August 25, 2006), the bankruptcy court for the Southern District of New York held that communications between an attorney and a corporate client's employees, for the purpose of obtaining legal advice, are privileged.  However, the privilege is stripped away when the communications are made in furtherance of contemplated or ongoing criminal or fraudulent activity.

Since the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, there have been discussions about the impact of Bankruptcy Code Section 503(c) a/k/a the "KERP Killer." As long as there have been KERPs (or key employee retention plans), creditors, creditors' committees and United States Trustees have argued about executive excesses and abuses.  With the enactment of Section 503(c), Congress took on these perceived abuses by adopting a set of rules that makes traditional KERPs difficult, if not impossible, to approve. In response, counsel for debtors immediately began repackaging KERPs as incentive plans ("produce value for pay") rather than retention plans ("pay to stay"). The hope was that incentive plans would be evaluated through the business judgment lens of Bankruptcy Code Section 363, as opposed to the strict new standard of Section 503(c).

On May 1, 2006, the Supreme Court used an opportunity presented by the Anna Nicole Smith bankruptcy case to resolve some confusion among federal courts about the probate exception to federal court jurisdiction. In Marshall v. Marshall, 126 S. Ct. 1735 (2006), the Court clarified and reaffirmed its sixty-year old holding in Markham v. Allen, 326 U.S. 490 (1946) that limited the cases categorically barred from federal courts under this exception to those that interfered with a state court's possession of probate property. Marshall's interpretation of the exception overturned the Ninth Circuit's opinion, which held that not only were direct challenges to wills and trusts excluded, but so were claims involving questions routinely decided by probate courts in determining the validity of an estate planning instrument.

In In re World Health Alternatives, Inc., Case No. 06-10166 (July 7, 2006), the Bankruptcy Court for the District of Delaware held that—notwithstanding the Third Circuit’s recent opinion, In re Armstrong World Indus., Inc., 432 F.3d 507 (3d Cir. 2005)—a secured creditor "give-up" or "carve out" that inures solely to the benefit of general unsecured creditors does not violate the Bankruptcy Code.

On May 30, 2006, the Internal Revenue Service (IRS) published Internal Revenue Bulletin No. 2006-22, Revenue Procedure 2006-24.  This bulletin sets forth the steps for a bankruptcy trustee or debtor in possession to follow in order to obtain a prompt determination by the IRS of any unpaid tax liability of the estate incurred during the administration of the debtor's case. The bulletin can be found at: http://www.irs.gov/irb/2006-22_IRB/ar12.html.

On June 22, 2006, the First Circuit decided Baena v. KPMG, Case No. 05-2868, affirming the district court's holding that the in pari delicto defense barred a trustee from bringing an action against an accounting firm that failed to notify the Debtor's corporate directors of accounting irregularities because the wrongful actions of the corporate officers were imputed to the Debtor as a whole.

On May 1, 2006, the United States Supreme Court denied the petition for a hearing filed by the Creditors' Committee in the Chapter 11 case of Owens Corning, Inc. See Official Representatives of the Bondholders and Trade Creditors of Debtors Owens Corning v. Credit Suisse First Boston, 126 S. Ct. 1910 (2006). The Creditors' Committee had sought to appeal the Third Circuit Court of Appeals' earlier decision regarding substantive consolidation in In Re Owens Corning, (3d. Cir. 2005). As a result of the Supreme Court's decision to deny the petition for writ of certiorari, the guidelines for determining whether substantive consolidation is appropriate are now settled in the Third Circuit. For a discussion of the Third Circuit's opinion in Owens Corning, see the November 29, 2005 positing on this site, "Third Circuit Adopts Stringent Test for Substantive Consolidation."

In In re Thickstun Brothers Equipment Co., Inc. No. 05-8054 (6th Cir. 06/02/2006), the Bankruptcy Appellate Panel for the Sixth Circuit held that a bankruptcy court lacks subject matter jurisdiction to determine whether a debtor's failure to object to a claim is preclusive in related state court litigation.

Central Virginia Community College v. Katz, 126 S. Ct. 990 (U.S. 2006), has significantly expanded the scope of the bankruptcy exception to states' constitutional sovereign immunity. In this 5-4 opinion, the U.S. Supreme Court held that state agencies do not enjoy sovereign immunity with respect to a proceeding to set aside a debtor’s preferential transfer because states implicitly subordinated their immunity to the Bankruptcy Clause (Article I, Section 8 of the Constitution) when the United States Constitution was ratified.

The National Association of Consumer Bankruptcy Attorneys (NACB) has issued a report that provides the first analysis of over 60,000 consumers who have filed for bankruptcy protection since the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act in October of 2006. The report, Bankruptcy Reform's Impact: Where Are All the Deadbeats, is available at: http://nacba.com. In its report, the NACB concludes that the changes put in place by Congress are not working as intended. Among other things, the report finds that of the 61,335 consumers seen so far by credit counseling firms nearly all are unable to repay any debts, and four out of five would-be filers were forced into dire financial straits by circumstances beyond their control, such as the loss of a job, catastrophic medical expenses or the death of a spouse.

In In re Dairy Mart Convenience Stores, Inc., 411 F.3d 367 (2nd Cir. 2005), the Second Circuit held that a Chapter 11 debtor was entitled to injunctive relief compelling state officials to accept the debtor's claims against the state's environmental clean-up fund as timely filed, based on the extension of time provided to debtors by Bankruptcy Code section 108. Although the injunction might ultimately lead to the debtor receiving money on account of its claims, the main relief sought was prospective – to prevent the continuing violation of federal law that the refusal to give effect to section 108 constituted. Thus, the Second Circuit explicitly held that the suit was not barred by the Eleventh Amendment, because the relief sought fell within the Ex Parte Young exception to the bar of sovereign immunity.

In "In re Siemon," 421 F. 3d 167 (2nd Cir. 2005), the Second Circuit Court of Appeals has joined the Third, Fifth, Sixth, and Ninth Circuit Courts of Appeal in holding that the 10-day limit set forth in the Federal Bankruptcy Rules for filing a notice of appeal is jurisdictional. Thus, absent a timely notice of appeal in the district court, the district court is without jurisdiction to consider the appeal, regardless of whether the appellant can demonstrate excusable neglect.

The Second Circuit has long held that nondebtor releases are proper only in rare cases where the injunction plays an important part in the debtor’s reorganization plan. See SEC v. Drexel Burnham Lambert Group, Inc. (In re Drexel Burnham Lambert Group, Inc.), 960 F.2d 285 (2d Cir. 1992). The Ninth and Tenth Circuits have gone still further, holding that nondebtor releases are prohibited by the Bankruptcy Code, except in the asbestos context. See Resorts Int’l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1401-02, 1402 n.6 (9^th Cir. 1995); Landsing Diversified Props.-II v. First Nat’l Bank and Trust Co. of Tulsa (In re W. Real Estate Fund, Inc.), 92 F.2d 592, 600-02 (10^th Cir. 1990) (per curiam).

In In re Ruehle, 412 F.3d 679 (6th Cir. 2005), the Court of Appeals for the Sixth Circuit joined a growing number of courts in rejecting the practice of "discharge by declaration." The debtor in Ruehle had included provisions in her Chapter 13 plan purporting to discharge her student loan debt without an adversary proceeding and stating that excluding the loan from discharge would impose an undue hardship on her, a process known as "discharge by declaration." On appeal, the debtor argued that the need for finality trumps the creditor's due process rights, citing as support two cases from the Ninth and Tenth Circuits.

In August 2005, the Advisory Committee on Bankruptcy Rules approved Interim Bankruptcy Rules and Official Forms designed to implement and reflect the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. These Interim Bankruptcy Rules were amended on October 13, 2005. The interim rules are designed to implement the substantive and procedural changes mandated by BAPCPA and are intended to bridge the gap between the effective date of BAPCPA and the promulgation of rules by the Supreme Court. As of December 1, 2005, certain of these rules and forms officially took effect. The full text of the new rules and forms is available at http://www.uscourts.gov/rules/archive.htm#bk2005, under "Bankruptcy." Some of the additional proposed rules and forms remained subject to public comment until February 15, 2006, and therefore, have not yet become effective. The text of these rules can be accessed at http://www.uscourts.gov/rules/newrules6.html#bk0804. Additional information on all the Interim Rules and Official Forms, as well as related legislative developments, can be found at www.uscourts.gov/rules. All of the revised forms are available at http://www.uscourts.gov/rules/new_and_revised_official_forms.html.

The Eleventh Circuit Court of Appeals, in Justice Cometh, Ltd. v. Lambert, 426 F.3d 1342 (11th Cir. 2005), has held that federal district courts have subject matter jurisdiction to adjudicate claims relating to the willful violation of the Bankruptcy Code's automatic stay. The appellate court found no merit in the contention that the district court has only appellate jurisdiction over such matters and that, therefore, a stay violation claim must be brought in the bankruptcy court rather than in the district court. 28 U.S.C. §§ 1331 and 1334 grant federal district courts original jurisdiction over all civil actions arising under Title 11.

The Internal Revenue Service has released a fact sheet regarding responsibilities under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which requires debtors to comply with certain tax-filing responsibilities. In general, the new law requires that debtors comply with their tax-filing responsibilities, make available previously-filed tax returns, in many cases, and seek credit counseling services. The Fact Sheet (FS-2005-18) is available on the IRS's website.

In April 2002, Robert Clauss, Esq., agreed to represent Randall Church in connection with a divorce decree. Clauss ultimately withdrew as Church's attorney, turning over all of his files to Church and releasing his attorney's lien. In September 2003, Church filed for bankruptcy relief, scheduling an outstanding debt to Clauss of approximately $32,000. Clauss asserted that this debt was nondischargeable under Bankruptcy Code section 523(a)(2)(A), contending that Church had obtained the benefit of his legal services by falsely representing that—regardless of whether he filed a bankruptcy case—he would not discharge the debt to Clauss but would pay it in full.

Late-filed claims are not automatically disallowed under the Bankruptcy Code, and under Section 502(b)(9), such late-filed, general unsecured claims are not invalidated to the extent excess funds remain after payment of timely filed claims. As stated by the Bankruptcy Appellate Court for the Eighth Circuit Court of Appeals: "The net effect of the foregoing is to subordinate the payment of late unsecured nonpriority claims to the payment of nonpriority unsecured claims for which proofs were timely filed." "In re Hollingsworth," 331 B.R. 399 (8th Cir. BAP 2005).

According to a press release by the Administrative Office of the U.S. Courts, the total number of bankruptcy filings for the three-month period from June 30, 2005 to September 30, 2005 represented the greatest number of filings recorded for any quarter in the history of the bankruptcy law. During the 12-month period ending Sept. 30, 2005, 1,782,643 bankruptcies were filed, up from the 1,618,987 bankruptcy cases filed in fiscal year 2004.

In the Owens Corning case, the Third Circuit Court of Appeals reversed an Order of the Delaware District Court substantively consolidating Owens Corning, certain of its subsidiaries that had received a $2 billion unsecured loan, and other subsidiaries that had guaranteed repayment of the loan. In Re Owens Corning, No, 04-4080, 2005 WL 1939796 (3d. Cir. Aug. 15, 2005).

On August 12, 2005, the United Bankruptcy Court for the District of Delaware held in Cooper v. Tech Data, (In re Bridgeport Holdings, Inc.) that clear and unambiguous provisions in a disclosure statement and reorganization plan, which specify the category of causes of actions to be preserved and the effect of any recovery, are sufficient to preserve those causes of action for post-confirmation adjudication. Bankruptcy Code Section 1123(b)(3) does not require "specific and unequivocal" identification of all preference claimants.

The "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005" (as the "Act") becomes effective Monday, October 17, 2005, and represents the biggest overhaul of bankruptcy law in more than 25 years. The major thrust of the Act is to limit an individual debtor's access to relief under chapter 7 of the bankruptcy code. Chapter 7 gives a debtor the right legally to discharge most debts after the debtor's non-exempt property is turned over to an appointed trustee for liquidation.

On September 20, 2005, the Eleventh Circuit Court of Appeals held in FINOVA Capital Corp. v. Larson Pharmacy Inc., et al. (In re Optical Technologies, Inc.), 2005 WL 2276420 (11th Cir. 2005), that an order confirming a plan of reorganization acts as a judgment given preclusive effect, and a bankruptcy court may not later void parts of its confirmation order based on "second thoughts" about its jurisdiction. The bankruptcy court "is bound to enforce the terms of the Plan as written" once confirmed. This case serves as a warning to all creditors that their rights and claims—even with respect to non-debtors—may be affected by a reorganization plan. Every party receiving a plan and disclosure statement should therefore carefully review these documents to determine whether their rights and claims may be affected and, if necessary, object to the plan or appeal the confirmation order before their rights are deemed waived.

Members of the House and Senate proposed three bills last week that seek to amend the new bankruptcy reform act in response to Hurricane Katrina.

In Dewsnup v. Timm, 502 U.S. 410 (1992), the US Supreme Court held that a debtor cannot avoid an undersecured lien under Bankruptcy Code Section 506(d), known as "stripping down" a lien. The Court did not consider, however, whether a debtor can avoid a wholly unsecured lien under Section 506(d), known as "stripping off" lien. The Delaware bankruptcy court recently considered the latter issue in In Re Pistritto, USBC Del., Case No. 03-10245 (April 19, 2005), and concluded that a Chapter 7 debtor cannot avoid a wholly unsecured consensual lien under Section 506(d).

On August 4, 2005, the Supreme Court of California held that pre-dispute waivers of the right to a jury trial are unenforceable under California law. "Grafton Partners L.P. v. Superior Court." The court based its ruling on California statutory construction and constitutional law principles. It held that the relevant statute, Section 631(d)(2) of the California Code of Civil Procedure, does not provide for pre-litigation jury trial waivers. It also held that the California Constitution does not permit the right to a jury trial to be waived absent an explicit statutory authorization.

In July 2005, the Fifth Circuit Court of Appeals held in Baker Hughes Oilfield Operations, Inc. v. Cage (In re Ramba, Inc.), 2005 WL 1581076 (5th Cir.), that a creditor's agreement to dismiss an involuntary bankruptcy petition in exchange for a debtor's payment of pre-existing debt—because it does not provide a "direct benefit" to the debtor—does not fall within the "contemporaneous exchange" exception to preference actions under 11 U.S.C. § 547(c)(1). The Fifth Circuit Court of Appeals decided this issue as a matter of first impression.

A secured lender that is a party to a written loan agreement—even one that expressly provides that it may not be amended or altered except in writing—may nonetheless be surprised to find itself bound by a loan officer's oral promises if the difference between the written loan agreement and the verbal promises is "drastic" and if the parties' conduct indicates that they considered the promises to have extinguished and replaced the lender's written loan agreement. See Fanucchi & Limi Farms v. United Agri Products, 2005 WL 1645694 (9th Cir. 2005).

In a unanimous decision, the United States Supreme Court recently reversed the Eighth Circuit Court of Appeals and held that debtors can exempt IRAs from the bankruptcy estate under section 522 (d)(10)(E) of the Bankruptcy Code. This decision now settles a division among the Courts of Appeal concerning the exemption of IRAs in bankruptcy cases.

The new amendments to the Bankruptcy Code change business as usual for key employees at companies entering bankruptcy. Prior to this year's amendments, companies in bankruptcy had wide discretion to offer retention bonuses in order to entice key employees to stay on board and guide the business through Chapter 11. Pursuant to the new amendments, the breadth of those incentives has been considerably reduced. So considerably reduced, in fact, that the effect may be that top executives start job hunting at the first sign of trouble and no longer stay with a company in bankruptcy.

With some exceptions, the new bankruptcy provisions do not become effective, and therefore applicable, until 180 days after enactment, or October 17, 2005. Since the new provisions are generally favorable to creditors at the expense of individual debtors, the general notion is that there may be a rush by potential individual debtors to file Chapter 7 petitions before October 17, 2005, so that they are not impacted by the new provisions. This could have a significant impact on lenders that make consumer loans or extend consumer credit -- e.g., home lenders, credit card lenders, household item financers -- because they may be inundated with Chapter 7 filings by their borrowers prior to October 17, 2005.

The general effective date for the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 is October 17, 2005. Cases commenced under title 11 on or after that date will be subject to the amendments made by this Act. However, a number of provisions are effective on a date other than October 17, 2005. The sections referenced below are sections of the Bankruptcy Abuse Prevention and Consumer Protection Act, not sections of the current Bankruptcy Code.

On Wednesday, April 20 2005, the President signed into law the "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005" (S. 256), which makes extensive changes to the Bankruptcy Code. Although the Act is widely known for its consumer provisions, it contains several sections that will affect business bankruptcies. Click here for the full text of the Bankruptcy Act and additional information.

On April 20 President Bush signed the "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005." This act represents the biggest overhaul of bankruptcy law in more than 25 years. While the focus of the act, and much of the publicity surrounding its passage, has centered on its consumer provisions, numerous other changes have been made to the bankruptcy laws that govern chapter 11 business reorganizations.