Bankruptcy and Restructuring Blog http://www.bankruptcylawblog.com/ en-us Copyright 2010 Thu, 18 Feb 2010 14:23:48 -0500 Thu, 04 Mar 2010 17:55:55 -0500 http://www.movabletype.org/?v=3.34 http://blogs.law.harvard.edu/tech/rss Equitable Subordination of a Creditor's Secured Claim when such Secured Creditor is, itself, in Bankruptcy In a majority opinion dated December 15, 2009, the Ninth Circuit Bankruptcy Appellate Panel held that a chapter 11 debtor may not equitably subordinate a creditor's claim and transfer the lien securing that claim, when such creditor is, itself, in bankruptcy, before first obtaining relief from the automatic stay under section 362 of the U.S. Bankruptcy Code in such creditor's bankruptcy case. Lehman Commercial Paper v. Palmdale Hills Prop. (In re Palmdale Hills Prop., LLC), 2009 Bankr. LEXIS 4294 (B.A.P. 9th Cir. Dec. 15, 2009).  

]]> It is well established that a bankruptcy court has the power to reorder the priority of allowed claims based on equitable grounds. Indeed, under section 510(c) of the Bankruptcy Code, if the principles of equity so dictate and after appropriate notice and a hearing, the bankruptcy court may subordinate all or part of an allowed claim, and transfer any lien securing such subordinated claim to the bankruptcy estate.  The decision in the Palmdale Hills case adds a wrinkle to this process when the creditor is in bankruptcy. According to Palmdale Hills, if the subject creditor happens to be in bankruptcy, relief from the automatic stay applied in such creditor's case upon filing must first be obtained before such creditor's secured claim can be equitably subordinated. 

The debtors in the Palmdale Hills case were integrated companies formed as part of a joint venture to develop residential real estate projects with affiliates of Lehman Brothers, Inc. Lehman and its affiliates, including Lehman ALI, Inc. ("Lehman ALI") and Lehman Commercial Paper Inc. ("Lehman Commercial"), provided the financing for the projects through a series of loan agreements and equity arrangements on the debtors' projects. The debtors contended that the structure of these financing arrangements constituted manipulative lending practices and fraudulent conveyances, and that Lehman's complete control over the use of the funds created their significant debt burdens and eventually forced them to file bankruptcy.

Soon after filing bankruptcy in California, the debtors sought blanket relief from the automatic stay in Lehman Commercial's bankruptcy case pending in New York. The purpose of this relief was to allow the Palmdale Hills debtors to administer their California bankruptcy cases without the need to file repeated motions for relief from the automatic stay in Lehman Commercial's New York bankruptcy cases.  However, the New York bankruptcy court denied the broad relief requested by the debtors without prejudice to the debtors' rights to refile specific requests for stay relief.

Eventually, the debtors proposed a chapter 11 plan based principally on equitably subordinating the claims of Lehman ALI (an entity not in bankruptcy) and Lehman Commercial (who is in bankruptcy, together with Lehman ALI, the "Lehman Lenders"). The debtors also filed an adversary proceeding against Lehman ALI to equitably subordinate its claim, which they later proposed to amend to include a request to equitably subordinate Lehman Commercial's claim and transfer its lien to the estate if the California bankruptcy court determined that such action would not violate the automatic stay applicable in Lehman Commercial's bankruptcy case.

The Lehman Lenders filed a motion for relief from stay in the debtors' California case arguing that they were owed more than $649 million on their loans to the debtors, and that the properties securing these loans lacked equity and were declining in value. The Lehman Lenders also argued that the debtors' reorganization would fail because it was based on equitably subordinating Lehman Commercial's claim, which Lehman Commercial argued violated the automatic stay applicable in its bankruptcy case.

The California bankruptcy court did not, however, grant the Lehman Lenders' stay relief motion, and instead treated it as an informal proof of claim. The court also ruled that the debtors could pursue equitable subordination, through either an adversary proceeding or a plan, as a defense to Lehman Commercial's stay relief motion without violating the automatic stay imposed in Lehman Commercial's bankruptcy case. Lehman Commercial appealed, challenging the California bankruptcy court's decision regarding the scope and application of Lehman Commercial's automatic stay.

The BAP reversed, holding that the California bankruptcy court erred in finding that the debtors could pursue equitable subordination of the Lehman Commercial's claim and transfer its lien to the estate without first obtaining relief from the automatic stay in Lehman Commercial's New York bankruptcy case. While the BAP agreed that equitable subordination could be asserted as a defense to a motion seeking relief from the automatic stay without the necessity for seeking relief from the automatic stay, the BAP concluded that, under the facts of the case, equitable subordination was not merely a defense to the relief from stay motion. According to the BAP, when the California bankruptcy court permitted the debtors to pursue equitable subordination of Lehman Commercial's claim, it conflated equitable subordination as a defense to a relief from stay motion with equitable subordination as an objection to a claim. Because the adjudication of the debtors' equitable subordination of Lehman Commercial's claim sought affirmative relief and was not merely a defense, it rose to the level of violating Lehman Commercial's stay. 

The BAP also rejected the debtors' contention that, because a complete disallowance of a claim through a claim objection could be achieved without a stay violation, their "lesser defensive remedy" of claim subordination could not possibly violate the automatic stay. The BAP noted that when a claim is disallowed, the creditor effectively never had the right to payment under that claim and the debtor did not recover any property from the creditor; whereas under equitable subordination, the creditor has a right to payment, but that right is modified based on equitable grounds and, if the claim is secured by a lien, that lien is transferred to the estate. According to the BAP, it was this key difference that transformed the debtors' claim of equitable subordination from a proper defense to Lehman Commercial's stay relief motion into an offensive action against Lehman Commercial's estate.

Finally, the BAP also noted that if the debtors were allowed to subordinate Lehman Commercial's claim in the California bankruptcy court without first moving for a stay relief in Lehman Commercial's New York bankruptcy case, Lehman Commercial's creditors would be deprived of notice and the chance to challenge the subordination action even though their rights would be affected.

One judge dissented in the Palmdale Hills case and disagreed with the majority's principal holding (as characterized by the dissent) that a debtor may not, in its own bankruptcy, unilaterally defend against a lender's inequitable claim if that lender is also a bankruptcy debtor. According to the dissent, the majority's distinction between claim disallowance and claim subordination is a distinction without a difference and does not constitute a good reason to require a debtor to seek permission of its creditor's bankruptcy court to avoid an equitable result in its own case. Alternatively, according to the dissent, Lehman Commercial waived its right to raise automatic stay issues once it filed its proof of claim. 

Ultimately, the Palmdale Hills decision represents a warning sign for a debtor in bankruptcy to tread carefully when dealing with claims filed in its own case. In light of the large number of bankruptcy filings in recent months, it may behoove such a debtor intending to equitably subordinate a creditor's claim, to first check the bankruptcy status, if any, of such creditor and avoid violating the creditor's automatic stay if it happens to be in bankruptcy itself.

Authored By:

Robert Sahyan
(415) 774-3146
rsahyan@sheppardmullin.com 

]]> http://www.bankruptcylawblog.com/9th-circuit-caselaw-equitable-subordination-of-a-creditors-secured-claim-when-such-secured-creditor-is-itself-in-bankruptcy.html http://www.bankruptcylawblog.com/9th-circuit-caselaw-equitable-subordination-of-a-creditors-secured-claim-when-such-secured-creditor-is-itself-in-bankruptcy.html 9th Circuit Caselaw Thu, 18 Feb 2010 14:23:48 -0500 updates@antitrustlawblog.com (Sheppard Mullin) The Bankruptcy Files: Haute Couture Edition To read this article on bankruptcies in the fashion industry published by American Lawyer, please click here, or visit the AmLaw Daily website.

]]> http://www.bankruptcylawblog.com/other-nationally-significant-cases-the-bankruptcy-files-haute-couture-edition.html http://www.bankruptcylawblog.com/other-nationally-significant-cases-the-bankruptcy-files-haute-couture-edition.html Other Nationally Significant Cases Fri, 16 Oct 2009 12:41:32 -0500 updates@antitrustlawblog.com (Sheppard Mullin) Bankruptcy Court Allows General Growth's "Bankruptcy-Remote" In a decision made on August 11, 2009, the U.S. Bankruptcy Court for the Southern District of New York allowed solvent, special purpose entity subsidiaries of a bankrupt parent company, General Growth Properties, Inc., to maintain their Chapter 11 bankruptcy cases, raising several important issues related to the use of special purpose entities structured to be "bankruptcy-remote." 

]]> GGP Business Model and 2009 Bankruptcy Filings

General Growth Properties, Inc. (GGP) is the ultimate parent company of approximately 750 wholly-owned subsidiaries, joint venture subsidiaries and affiliates, including various Special Purpose Entities or SPEs. The GGP Group owns and manages over 200 shopping centers in 44 states in the United States. As of December 31, 2008, the GGP Group's capital structure included approximately $18.27 billion in debt, partly secured by mortgages on the individual properties of the company. The secured debt consisted of both conventional mortgage debt as well as debt that was securitized in the Commercial Mortgaged-Backed Securities (CMBS) market. The typical mortgage loan for the GGP Group had a three to seven-year term, with low amortization and a large balloon payment at maturity. Penalties for failure to repay or refinance upon maturity included a steep increase in interest rate, a cash requirement, and a requirement that certain expenditures be submitted to the lender for approval. The GGP Group sought to avoid these penalties by refinancing its loans prior to the maturity date.  

As the credit crisis spread to the CMBS market in the latter half of 2008, prompting a change in commercially acceptable loan terms, the GGP Group was unable to refinance its maturing debt or to obtain new financing. After experiencing liquidity problems and defaulting on various loans, approximately 390 debtors within the GGP Group filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code in April 2009. Thereafter, certain Lenders, as well as the servicers to certain CMBS lenders, of the GGP Group debtors filed motions to dismiss the bankruptcy cases of twenty of the GGP Group's SPE Debtors. The Lenders argued that the bankruptcy cases of these SPE Debtors were filed prematurely in that there was no imminent threat to the financial viability of the SPE Debtors, which were cash-flow positive. The Lenders further argued that the filings were in bad faith since there was no possibility of confirming a plan over the objection of the Lenders and, therefore, no real chance of reorganization, and because the SPE Debtors replaced their independent managers just prior to the bankruptcy filings.

The SPEs of the GGP Group were bankruptcy-remote entities, as evidenced by various provisions in their organizational documents including (i) prohibiting consolidation of GGP’s various SPEs, (ii) restricting mergers and asset sales, and (iii) requiring that one or more "independent" directors or managers be retained by each SPE. Such features are consistent with common practice in the securitization market. The bankruptcy-remote structure of the SPE is an important consideration for commercial real estate lenders in protecting loan collateral from becoming subject to the risks of bankruptcy. Specifically, independent directors or managers not associated with an SPE, its parent or affiliates would be more likely to consider a bankruptcy filing objectively without the motivation to use such a filing to benefit the equity holders of the SPE. Conventional wisdom was that the existence of independent directors or managers eliminated the risk of a bankruptcy filing.

However, in the case of the GGP Group, these features of the SPE structure failed to prevent the SPE Debtors from filing for bankruptcy. On August 11, 2009, the U.S. Bankruptcy Court for the Southern District of New York issued a decision in In re General Growth Properties, Inc., et al. (Bankr. S.D.N.Y., Case No. 09-11977) that denied the motions to dismiss the bankruptcy cases of the SPE Debtors holding, as a general matter, that there was no evidence of prematurity or bad faith in the filings by the SPE Debtors. 

The Bankruptcy Court Ruling

In denying dismissal, the U.S. Bankruptcy Court for the Southern District of New York applied the standard for the dismissal of a bankruptcy as outlined in the case of C-TC 9th Ave. P’ship v. Norton Co. (In re C-TC 9th Ave. P’ship), 113 F.3d 1304 (2d Cir. 1997), stating that grounds for dismissal exist if it is clear on the filing date "there was no reasonable likelihood that the debtor intended to reorganize and no reasonable probability that it would eventually emerge from bankruptcy proceedings."  The court analyzed both the objective futility of the SPE Debtors' bankruptcy filings and whether the debtors exercised subjective good faith.  

In determining that the bankruptcy filings of the SPE Debtors were not premature, the Court found:
 

  • Insolvency is not a requirement: Although the SPE Debtors were cash-flow positive at the time bankruptcy was filed and certain of the SPE Debtors did not have debt maturing for several years, the Bankruptcy Code does not require that a debtor be insolvent when a bankruptcy case is filed under Chapter 11. The state of the CMBS market and the difficulties of the GGP Group in refinancing and obtaining new loans demonstrated that each of the SPE Debtors was in severe financial distress and had ample justification for filing the Chapter 11 petitions.
     
  • SPE may consider the interests of the group: The SPE Debtors were justified in considering the interests of the entire GGP Group in deciding to file for bankruptcy. Although each SPE was a separate entity, many of the mortgage loans were guaranteed by other GGP entities, and certain loans were advanced by one lender to multiple debtors. The Court noted that the Lenders to the SPEs were aware that they were extending credit to an entity that was part of a much larger group, and that there were benefits as well as possible detriments from this structure.  
     
  • Ability to confirm a plan not a requirement to a bankruptcy filing: The Court found that the debtors were not required to prove that a plan for reorganization is confirmable in order to file a petition under the Bankruptcy Code.
     

In addition, the Court determined that the Lenders failed to demonstrate that the SPE Debtors exercised bad faith in filing petitions for bankruptcy based on the following:
 

  • No requirement for negotiation with Lenders prior to a bankruptcy filing: Although the Court acknowledged that there are often good reasons for such negotiations to take place, the Bankruptcy Code does not require that a borrower negotiate with its lender prior to filing a petition. The Court found that there was no evidence that pre-filing negotiations would have been adequate to deal with the problem and, further, that there was no evidence that the Lenders would have been willing to work with the SPE Debtors.
     
  • The discharge and replacement of Independent Managers by the SPE Debtors did not constitute bad faith: The Court found that while the SPE Debtors terminated their independent managers on the eve of the bankruptcy filings and replaced them with select individuals to serve as successor managers in order to facilitate the SPE Debtors' bankruptcy filings, these actions did not constitute subjective bad faith sufficient to require the dismissal of the bankruptcy cases. The SPE Debtors did not violate any provisions of their corporate documents. In addition, the Court noted that the successor independent managers exercised their rights to support the bankruptcy filings of the SPE Debtors in a manner consistent with their fiduciary duties, as the independent managers do not have a duty to keep the SPE Debtors from filing for bankruptcy, but rather a duty to act in the interests of a company and its shareholders or equity owners.
     

Ultimately, in denying the motions of the Lenders to dismiss the cases, the Court noted that although the bankruptcy filings pose an inconvenience to the Lenders by partially interrupting the cash flows of the SPE Debtors and requiring the appointment of special servicers for the CMBS obligations, the fundamental creditor protections that the Lenders negotiated and that the SPE structure represents were in place and would remain in place during the bankruptcy cases. These include protections against the substantive consolidation of the SPE Debtors with any other entities.

Conclusion

The Court’s decision in the GGP case highlights significant points and considerations relating to the use of SPEs in securitization market, including that:
 

  • The financial difficulties of a corporate group could result in the bankruptcy filing of a solvent, bankruptcy-remote SPE.
     
  • The termination and replacement of independent managers or directors of an SPE may not be evidence of bad faith of an SPE if such termination and replacement complies with the organizational documents of the SPE.  This may prompt Lenders to require in the loan documents that they be notified prior to changes in the managers or directors of SPEs.
     

Undoubtedly, the full impact of the GGP case will become evident as the lending industry adjusts its expectations and practices in dealing with bankruptcy-remote SPE entities in light of this decision.

Authored By:

Robyn Young
(212) 332-3527
ryoung@sheppardmullin.com 

]]> http://www.bankruptcylawblog.com/other-nationally-significant-cases-bankruptcy-court-allows-general-growths-bankruptcyremote.html http://www.bankruptcylawblog.com/other-nationally-significant-cases-bankruptcy-court-allows-general-growths-bankruptcyremote.html Other Nationally Significant Cases Thu, 10 Sep 2009 08:24:21 -0500 updates@antitrustlawblog.com (Sheppard Mullin) New FCA Rules Put Lenders and Brokers Directly in Their Gun Sights The author is a member of the Firm's Government Contracts & Regulated Industries Practice Group. For additional articles and postings concerning this and related topics, please refer to Sheppard Mullin's Government Contracts Blog, which can be found at www.governmentcontractslawblog.com.

I.  INTRODUCTION

Without a doubt, the False Claims Act ("FCA") has been dramatically changed in the last few months. As will be discussed in more detail herein, it certainly appears that the FCA has been retooled so that the playing field is now stacked in favor of the government and qui tam plaintiffs. There is also every indication that lenders who have federally insured mortgages, redevelopment funding, or other financial support from the government, are at risk of being sued for false claims unless they take certain precautions to educate and protect themselves.

]]> In fact, it is a good idea for all companies who receive government funding (e.g., defense contractors, health care providers, academic institutions) to look closely at their internal compliance programs, and modify them to reflect the recent changes in the FCA. This article is intended to offer some specific suggestions, and also encourage companies to have their programs amended, and implemented by legal counsel who are receptive to flexible billing arrangements including flat fee schedules.
 

II. MANY OF THE HURDLES TO LITIGATING FALSE CLAIMS ACTIONS HAVE BEEN REMOVED

The following are some of the more significant changes to the FCA: 
 

(1) There is essentially no time bar for the government to intervene in the private party ("relator") action – the government can easily have its complaint relate back to the timely filing of the relator action.

(2) The government can now essentially "deputize" private parties and local governments to aid in the pursuit of these actions, by sharing documents and testimony that the government has obtained through Civil Investigative Demands ("CIDs"). The FCA now expressly authorizes the sharing of information obtained under a CID with "any qui tam relator," with federal, state or local government agencies, and with other interested persons (i.e., courts, consultants, auditors, experts, arbitrators) if it is done in connection with an investigation, case or proceeding. Thus, it is even more important now to involve legal counsel early on in negotiating the parameters of the CID, and coordinating the company's response.

(3) The universe of potential relators has been expanded dramatically, and can include contractors and agents, all of whom appreciate the considerable financial windfall that relators recover in qui tam actions with treble damage awards. Since the 1986 amendments, qui tam plaintiffs have accounted for more than half of the over $21.5 billion recovered under the FCA, with the plaintiffs recovering anywhere from 15-30% of the government's recovery. Thus, companies need to worry not only about disgruntled and terminated employees who may recast themselves as possible "whistleblowers," but also contractors with whom relations have become strained for any reason.  The FCA anti-retaliation provision now applies to contractors and agents in addition to employees.

(4) Subcontractors or others who submit a bill for payment to a recipient of government funds can now be held liable under the FCA, even if their bill is not submitted to the government directly. The definition of "claim" in the FCA has been expanded to include these indirect claims, so long as the funds involved are used on behalf of the government or in furtherance of a government program or interest. For example, in the context of federally insured mortgages, the government support is provided based on a private entity certifying that the borrower has complied with a variety of criteria underlying the loan agreements, any of which could form the basis of a false claims action, even if the certifying entity is not submitting a claim to the government.

(5) In amending the FCA, Congress specifically rejected several court decisions that made it more difficult for plaintiffs to establish liability. For example, the Allison Engine requirement that a claim or statement must be designed "to get" false claims paid or approved has been relaxed considerably, with the FCA amendments:
 

These amendments to Section 3729 clarify that the False Claims Act was intended to extend to any false or fraudulent claim for government money or property, whether or not the claim is presented to a government official or employee, whether or not the U.S. Government has physical custody of the money, and whether or not the defendant specifically intended to defraud the U.S. government. With this change, the additional elements read into the statute by the Supreme Court and the D.C. Circuit decisions are vitiated, and Allison Engine and Totten would be overturned by this legislative action.
 

February 5, 2009, Statement of Sen. Patrick Leahy, Chairman, Senate Judiciary Committee, Introduction of Fraud Enforcement and Recovery Act of 2009. Thus, the specific intent element that the United States Supreme Court imposed in Allison Engine, to keep FCA enforcement from becoming effectively "boundless," has been removed. To establish FCA liability now, the plaintiff only needs to prove that the false statement was "material" to the government's decision to pay a false claim. "Material" is defined loosely as "having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property." 

In addition, there are further amendments moving through Congress that would also increase the number of FCA plaintiffs. Most significantly, the "public disclosure" defense to qui tam suits would be greatly weakened by eliminating the FCA defendant's right to move to dismiss a relator complaint based on the public disclosure bar. Further, the bills would redefine what constitutes "public disclosure" to make it more narrow, and also allow a court to dismiss a qui tam action only if the "allegations relating to all essential elements of liability of the action or claim are based exclusively on the public disclosure of allegations or transactions…." When viewed in the context of the vast amount of public information that is available through the Internet, the elimination of this defense for defendants could exponentially increase the number of private plaintiff suits. Given the speed with which the recent amendments were approved by Congress and signed by the President, there should be little doubt that further amendments in favor of qui tam plaintiffs are just a matter of time.

III. THE GOVERNMENT IS TARGETING THE MORTGAGE LENDING BUSINESS, AND USING THE FCA TO DO IT

These changes also come with considerable bite behind them with the government approving substantial spending budgets for enforcement purposes. The bill authorized $155 million a year for hiring fraud prosecutors and investigators at the Justice Department for fiscal years 2010 and 2011, with the expectation that the FBI can double the number of its mortgage fraud task forces nationwide – from 26 to more than 50. 

Finally, if there is any remaining doubt that the FCA is a powerful tool that the government is using to prosecute mortgage fraud, then the following remarks are worth considering, in addition to the cases that the government has been litigating in the last year. In introducing the Anti-Fraud Legislation that included the amendments to the FCA, Senator Patrick Leahy said, "The federal government has spent hundreds of billions of dollars to stabilize our banking system, and Congress will soon spend even more to restart our economic recovery. But to date, we have paid far too little attention to investigating and prosecuting the mortgage and corporate frauds that has so dramatically contributed to this economic collapse." Similarly, President Barack H. Obama in signing the bill stated: "This bill nearly doubles the FBI's mortgage and financial fraud program, allowing it to better target fraud in hard-hit areas. That's why it provides the resources necessary for other law enforcement and federal agencies, from the Department of Justice to the SEC to the Secret Service, to pursue these criminals, bring them to justice, and protect hardworking Americans affected most by these crimes."

Recent cases are a good indication of the mortgage industry practices that are coming under scrutiny. In June 2009, Beazer Homes USA Inc. agreed to pay $5 million to the United States, plus contingent payments of up to $48 million dollars to be shared with victimized private homeowners, to resolve allegations that Beazer Mortgage Company was involved in fraudulent mortgage origination activities with federally insured mortgages. Beazer allegedly induced unqualified home buyers to enter into Federal Housing Administration ("FHA") insured mortgages, and, then, when the buyers defaulted, the FHA was wrongfully required to pay on the mortgage insurance claims.

Similarly, mortgage lenders who offer HUD-insured mortgages are becoming the subject of false claims actions. In this scenario, the HUD approved lender can "directly endorse" a mortgage for low and middle-income buyers under certain conditions, but can be held liable if the lender submitted unqualified loans to the HUD for insurance endorsement, without disclosing that the loans did not satisfy FHA guidelines. (Nat'l City Mortgage, June 2, 2008, $4.6 million settlement; and RBC Mortgage, November 25, 2008, $10.71 million settlement).

Presently pending in the United States District Court in Los Angeles, California is an action against mortgage lender Capmark Finance, Case No. CV 09-04104 RSWL (JCx), in which, the government is seeking to recover damages and penalties under the FCA arising from Capmark's submission of allegedly false documents and claims to HUD's multifamily mortgage insurance program. Specifically, the complaint alleges that Capmark engaged in fraudulent conduct to obtain HUD mortgage insurance in connection with two loans made by Capmark that financed the borrowers' acquisition of two existing residential nursing home facilities. When the loans defaulted, HUD sustained losses by having to pay $25.9 million dollars in mortgage insurance claims. In the Department of Justice press release for the Capmark case, the Department of Justice representative stated, "Mortgage fraud is a top priority for this Administration, especially when public dollars are at stake. We will aggressively pursue fraud claims against federal mortgage insurance programs, which are so vitally important to this economy." Thus, all loans at risk of default that are covered by government mortgage insurance are ripe for possible false claims actions.

IV. IT IS A PRUDENT BUSINESS PRACTICE FOR COMPANIES, INCLUDING THE MORTGAGE LENDING SECTOR, TO PROTECT THEMSELVES THROUGH EFFECTIVE COMPLIANCE PROGRAMS AND REGULAR INTERNAL AUDITS

There are a number of reasons why it is in a company's best interest to have a current and effective compliance program in place. Early discovery of possible FCA violations can create opportunities for voluntary disclosure, provide a basis for resolving the problems through a negotiated settlement, and shorten the damages time period by identifying problems early on. In light of the recent amendments to the FCA, compliance programs should be updated along the following lines, with additional modifications tailored to the particular needs of the company: 
 

(1) Schedule internal audits of all agreements that involve federal funds that may be at risk, including, without limitation, federally insured loans to at risk borrowers.

(2) Establish an alert system for identifying agreements where the payments are overdue, and there is a risk that the contract will be breached, or the property foreclosed in the case of a mortgage loan.

(3) Establish an audit system of agreements involving subcontractors with whom the company has either terminated the relationship, or the relationship has become strained, in order to ensure that the underlying agreements were handled properly and, therefore, there is no basis for a qui tam complaint by a subcontractor or, alternatively, any problems can be identified and addressed.

(4) Evaluate the advantages and disadvantages of having a hotline system for contractors and agents to report FCA concerns, now that they are included in the class of possible qui tam plaintiffs.

(5) Remind all company departments that prompt notice to management upon receipt of any subpoena or government inquiry is essential. Now that the documents and testimony produced in response to a CID can be shared more broadly, it is even more critical that companies work with legal counsel in complying with these requests.


For further information concerning our Government Contracts Practice, contact our Practice Group Leaders, Bryan Daly in Los Angeles at (213) 617-5466 and Anne Perry in Washington, D.C. at (202) 218-6875.

Authored by:

Michelle Sherman
(213) 617-5405
msherman@sheppardmullin.com

and

Peter Morris
(213) 617-5414
pmorris@sheppardmullin.com

]]> http://www.bankruptcylawblog.com/other-nationally-significant-cases-new-fca-rules-put-lenders-and-brokers-directly-in-their-gun-sights.html http://www.bankruptcylawblog.com/other-nationally-significant-cases-new-fca-rules-put-lenders-and-brokers-directly-in-their-gun-sights.html Other Nationally Significant Cases Fri, 14 Aug 2009 08:14:11 -0500 updates@antitrustlawblog.com (Sheppard Mullin) The Precedential Value of an Unprecedented Sale - Lessons from Chrysler On June 10, 2009, the sale of substantially all of Chrysler's assets closed, just 42 days after the country's third largest automaker filed for bankruptcy protection. The closing followed a contentious sale hearing before the Bankruptcy Court, an expedited appeal to the Second Circuit Court of Appeals and a brief stay imposed by the United States Supreme Court. The source of the contention: three Indiana state pension funds, arguing that the sale of Chrysler's assets constituted a sub rosa plan of reorganization that upended the priority scheme of the Bankruptcy Code. Rejecting the Indiana pension funds' arguments and approving the sale, a decision upheld on appeal, the Bankruptcy Court avoided mention of the effect of unprecedented the governmental intervention in its analysis, relying on its interpretation of applicable bankruptcy law. As the sale process in the bankruptcy of General Motors nears completion, much has been learned from Chrysler.

]]> The Chrysler Sale Transaction and Indiana Pensioners' Objections

Chrysler LLC and 24 of its domestic direct and indirect affiliates filed for Chapter 11 protection on April 30, 2009 in the United States Bankruptcy Court for the Southern District of New York. Shortly thereafter, Chrysler filed a motion seeking approval of the sale of substantially all of its operating assets to "New Chrysler" in exchange for $2 billion in cash and the assumption of certain liabilities. As part of the transaction, New Chrysler entered into two agreements with the UAW: a new collective bargaining agreement in which the UAW made unprecedented concessions and a settlement agreement relating to a 2008 class action that established a voluntary employees' beneficiary association, or VEBA, to fund legacy retiree health care obligations. Pursuant to the settlement agreement, the VEBA would be funded with a 55% membership interest in New Chrysler and a new $4.587 billion note. The remaining membership interests in New Chrysler would be issued to U.S. and Canadian governmental entities and a subsidiary of Fiat S.p.A. Ultimately, New Chrysler would be funded entirely by the U.S. and Canadian governments, contributing $6 billion in senior secured financing to support New Chrysler's operations after the sale.

The Indiana pension funds which challenged the sale held approximately $42 million (less than 1%) of Chrysler's $6.9 billion first-priority secured debt pursuant to an Amended and Restated First Lien Credit Agreement secured by substantially all of Chrysler's assets. The Indiana pension funds raised multiple objections to the proposed sale, including that it violated the Emergency Economic Stabilization Act of 2008 and the Troubled Asset Relief Program. However, its primary complaint was that the sale transaction constituted a sub rosa plan of reorganization that violated the priority scheme of the Bankruptcy Code because it sold all of the first lien lenders' collateral and essentially distributed the proceeds of the sale to unsecured trade creditors and the UAW.

Lesson One: A Quick Sale is Nothing More Than a Quick Sale

Section 363 of the Bankruptcy Code authorizes a debtor-in-possession, after notice and a hearing, to use, sell or lease property of the estate outside of the ordinary course of its business. However, a sale of assets under section 363 that, in essence, would direct or effectuate the terms of a reorganization plan is considered an impermissible sub rosa plan of reorganization. The rationale for barring such attempts is that they deprive creditors of the comprehensive protections normally afforded to them in the plan confirmation process, including formal disclosure, an opportunity to vote on acceptance and a fully noticed confirmation process. While a section 363 sale requires court approval and gives creditors the right to object, the more stringent and time-consuming plan confirmation requirements are not present. Thus, where a section 363(b) sale would preempt or dictate the terms of a plan, the sale should not be authorized. The Indiana pension funds argued that the Chrysler sale transaction was a sub rosa plan of reorganization in that it would sell their collateral to New Chrysler, which would use it to satisfy over $20 billion in unsecured creditor claims, leaving the first lien lenders with only 29% of the value of its collateral.

In rejecting this argument, the Court noted that the standard in the Second Circuit for determining whether to authorize a section 363 sale prior to and outside of the plan confirmation process is, simply, whether there was a "good business reason" for such a sale. The Court held there was an articulated business justification for the sale and for the necessity of completing it quickly. Moreover, the Court held that the sale was not a sub rosa plan of reorganization because the Debtors were receiving fair value for the assets being sold and all of the proceeds from the sale would be paid to the first lien lenders. 

Avoiding Violations of the Priority Scheme

Chapter 11 of the Bankruptcy Code requires, among other things, that a plan be fair and equitable and not discriminate unfairly among similarly situated creditors. The absolute priority rule, a fundamental principle of U.S. bankruptcy law, provides that a plan is fair and equitable if an unsecured creditor or other priority creditor receives full value for its claim or, if it does not receive full value, thatthe holder of any junior claim will not receive any property on account of such junior claim.  The words 'fair and equitable' are terms of art meaning senior interests and claims are entitled to full priority over junior ones.  The Indiana pension funds argued that allowing Chrysler "to ignore the priority scheme established by the Bankruptcy Code while selling substantially all of their assets, in permanent derogation of the Indiana Pensioners' property rights, would turn the law on its head." Specifically, they argue that the sale violates the priority scheme of the Bankruptcy Code because (i) the first lien lenders will be not be paid in full while U.S. and Canadian governmental entities, junior lienholders under Chrysler's TARP debt, will receive value; and (ii) the first lien lenders' $4.9 billion unsecured deficiency claim will ultimately be treated differently than the general unsecured claims of certain trade creditors and the UAW.

In rejecting these arguments, the Court emphasized three points. First, the membership interests in New Chrysler were not issued to the UAW and the U.S. and Canadian governments on account of their prepetition claims, but rather were issued as consideration for the contribution of new value. The U.S. and Canadian governments are providing New Chrysler with approximately $6 billion in funding, while the UAW is providing New Chrysler with a skilled workforce under a more competitive cost structure and a more restrictive collective bargaining agreement. Second, the membership interests in New Chrysler were issued pursuant to agreements between each party and New Chrysler, and not Chrysler as debtor. The consideration provided by New Chrysler was not value that would otherwise inure to the benefit of Chrysler's estate, so the agreements did not divert value from Chrysler's estate or allocate proceeds from the sale of its assets. Finally, parties to contracts that are assumed in a bankruptcy case are entitled to cure payments and adequate assurance of future performance -- the Bankruptcy Code recognizes that certain creditors may receive more favorable treatment than other creditors, either in their class or a higher priority class, as part of a sale, and that such disparate treatment does not violate the priority rules. 

Adequacy of Notice is in the Eye of the Beholder

Rule 2002 of the Bankruptcy Rules requires at least 20 days notice of a section 363 sale, unless otherwise ordered by the Court. While the Chrysler sale hearing began more than 20 days after Chrysler filed its sale motion, the Indiana pension funds, as well as many other parties, objected to the abbreviated and rushed sale process. As the Indiana pension funds stated in their objection, Chrysler "acted as if they were selling a Chrysler LeBaron and not a multinational corporation with billions of dollars in assets." They argued that the sale process effectively precluded anyone but New Chrysler from bidding on Chrysler's assets, was inherently unfair and failed to maximize the sale price. 

In holding that the notice provided was adequate, the Court focused on the need for expedited relief to prevent the erosion of the value of Chrysler's assets. The Court found that despite the complexity of the transaction, notice of the sale was adequate where information about Chrysler's troubles were known worldwide prior to the bankruptcy, there had already been an extensive marketing attempt, and the assets were "wasting" away. Adequacy of notice is to be judged on what is adequate under the circumstances of each case.

The Lessons

The Chrysler bankruptcy case demonstrate the flexibility of the Bankruptcy Code, which has permitted Bankruptcy Courts to adapt to and confront the challenges and turmoil of these unprecedented economic times. The Bankruptcy Court's decision to approve the Chrysler sale transaction relied upon the familiar values underlying U.S. bankruptcy law: equity, rehabilitation and the right to a fresh start. Although other Bankruptcy Courts, faced with less dire consequences, may act with more deliberation, the effect of the Chrysler bankruptcy case, and the precedent it has set, is undeniable.

Authored By:

Malani J. Cademartori
(212) 332-3847
mcademartori@sheppardmullin.com

and

Blanka Wolfe
(212) 332-3822
bwolfe@sheppardmullin.com

]]> http://www.bankruptcylawblog.com/assets-sales-and-acquisitions-the-precedential-value-of-an-unprecedented-sale-lessons-from-chrysler.html http://www.bankruptcylawblog.com/assets-sales-and-acquisitions-the-precedential-value-of-an-unprecedented-sale-lessons-from-chrysler.html Assets Sales and Acquisitions Tue, 14 Jul 2009 11:14:46 -0500 updates@antitrustlawblog.com (Sheppard Mullin) Considerations for Service on an Unsecured Creditor's Committee With bankruptcy filings up by more than 25% in the recent past, and with the promise of many more to come in the near future, an increasing number of businesses and individuals may find themselves listed amongst the largest unsecured creditors of a debtor and with much to lose in a bankruptcy case. As one of the largest creditors, these same businesses and individuals may also find themselves being solicited to serve on “official” unsecured creditors’ committees. While a creditor who is already owed significant amounts of money by a debtor may consider any further time or effort expended in connection with a debtor to be a waste of resources, serving on a creditors’ committee can often be a valuable opportunity to be involved in the direction a debtor's case and reorganization (or ultimate liquidation) will take and to ensure the maximum recovery for all unsecured creditors, including itself. This article provides a brief overview of what a committee is, who may serve on a committee, what service entails, and some of the pros, cons and other considerations of and for serving on a creditors committee.

]]> What is a committee?

The formation of an official committee of unsecured creditors is provided for under section 1102 of the U.S. Bankruptcy Code. Pursuant to section 1102, the U.S. Trustee is tasked with forming the unsecured creditors' committee (and any other committees the U.S. Trustee may deem necessary) as soon as possible after a debtor files for chapter 11 relief. Accordingly, the process for choosing and appointing a committee will begin within days after the bankruptcy filing with the U.S. Trustee sending solicitation letters and questionnaires to the largest unsecured creditors identified by the debtor as part of its chapter 11 petition. The solicitation letters will designate a date, time and place for an organizational meeting at which the U.S. Trustee will review the completed questionnaires and choose a committee who represents the general unsecured creditor body in both type and amount. An unsecured creditors’ committee can be comprised of anywhere between three and eleven members, but is usually made up of no less than five and no more than seven members. On occasion, creditors hoping to garner a spot on the committee which were not originally contacted by the U.S. Trustee or listed among the ranks of the largest creditors of a debtor may be able to do so by exhibiting they have expertise and knowledge in the debtor’s particular industry, or by demonstrating that their claims are not adequately represented among the largest creditors designated by the debtor and solicited for committee membership. In some cases, an additional committee representing the debtor's shareholders or bondholders may also be appointed if the U.S. Trustee and bankruptcy court sees a need and there is sufficient interest to do so.

Once formed, the committees has the right, subject only to bankruptcy court approval, to retain and consult counsel and other professionals of their own choosing to represent the committee as a whole (as opposed to the individual members and their individual interests). Committees will generally retain counsel and/or financial advisors immediately after formation through an expedited interview process. As a statutorily created entity, both the "reasonable" fees and expenses of the professionals selected to represent the committee, and the "reasonable" expenses (but not the fees) incurred by the committee members in serving on the committee, are paid and reimbursed out of the debtor's estate. In this way, the committee members do not come out of pocket for their service on the committee.

It should be noted, however, that the fees and expenses for the attorneys and professionals retained by each individual member to represent its own specific interests, issues and claims in the bankruptcy case will not be paid for by the debtor's estate and will be the sole responsibility of the individual member as a single creditor of the debtor (please also note that it is advisable to retain individual counsel in connection with the bankruptcy case even if serving on a committee, since the committee is representative of all creditors and not individual interests which may, from time to time, be adverse to a specific creditor's interests).

What are the committee's responsibilities?

Committees can play an integral role in shaping the course of a bankruptcy case. Although the ordinary day-to-day operations of a chapter 11 debtor's business are normally determined by the debtor's existing management, a committee can influence both the long-term strategy of the debtor's business and affect any decisions it made out of the ordinary course of a debtor's business and which may affect creditors generally.

As mentioned above, the committee's purpose is to represent the interests of all unsecured creditors of the debtor, and to act as a watchdog for those interests while the bankruptcy case is pending.

In pursuing this purpose, the committee, through its professionals, will need to investigate and become knowledgeable about the debtor's business and its background, and be involved in the debtor's decision making. The committee will, therefore, be in a unique position to review the liabilities and assets of the estate and to influence or sometimes take action where necessary. For example, a debtor may not want to dispute a creditor's claim if they are dependent on that business relationship in the debtor's on-going business or may resist avoiding a transfer made to an insider. In these situations, the committee may be the only party willing and able to ask such questions or bring such actions derivatively to augment the estate for the benefit of all creditors.

In addition and most importantly, the committee will have the unique role of acting as advisor to the bankruptcy court in the bankruptcy process. For example, bankruptcy courts will often look to the committee any time a debtor seeks court approval to enter into an agreement outside the ordinary course of business or dispose of any assets. Ultimately, and through the discharge of these duties and actions, the committee is integral to the direction and success of a debtor's bankruptcy case, and will assess and influence whether the debtor reorganizes or liquidates and the distribution that unsecured creditors will receive under either scenario.

The advantages and disadvantages of committee service.

Serving on a bankruptcy committee is a somewhat significant responsibility.

Time Commitment. Serving on a committee may require a considerable amount of time. The time commitment will vary depending on the complexity of the case; however, the typical committee may meet several times a month, usually via telephonic conference for minimum disruption. In any event, the time spent on the committee is going to take time away from other business activities, and in most cases will be time which would not have been spent on an insolvent party from whom you are likely to recoup on a fraction of what you are owed. In addition, since service is voluntary, committee members are not directly compensated for the considerable time they may expend (although committee members do receive reimbursement for expenses as described above).

Acting as a Fiduciary. The committee and its members have a fiduciary duty to act in the best interests of the unsecured creditors as a whole. As such, committee members have a duty they must discharge and for which they are accountable. Specifically, as a fiduciary, committee members are prohibited from using the confidential information gained in their service on the committee to their own advantage or from trading on their claims (or any securities held by such members in the debtor) based on such information. Practically speaking, this would prohibit any such member from taking any action which may appear to be in violation of this duty, including effectively prohibiting any securities or claims trading because of an assumption that such trading was based on insider information. Nevertheless, any committee member may pursue and defend its claim and defend against any claims brought against it by the estate, provided the committee member does not use any confidential information it learns as a member of the committee.

There are, however, significant advantages to serving on a committee:

Providing your opinion. The committee has a fiduciary responsibility to represent the interests of all similarly situated parties, i.e. all the unsecured creditors. As such, a bankruptcy judge relies heavily on the committee's opinions and recommendations, as opposed to the self-interested view of one creditor. Being a member of the committee enables a creditor to influence how their own claim is treated and their recovery, along with the claims of all creditors.

Sharing costs and cutting down costs. Because the committee will hire its own attorneys and financial advisors, a creditor serving on the committee may often find that its interests are, necessarily, aligned with the entire committee in taking action or objecting to an action. Asserting those positions through the singular voice of the committee and its professionals saves costs to the individual creditor in taking or opposing action on its own. Moreover, while payment from the debtor's assets will decrease the amount of the estate available to pay creditors in the long run, the cost of those professionals is disbursed evenly among all the creditors which the committee is formed to benefit.

Networking opportunities. Participating on a committee provides a unique opportunity to work with other individuals involved in the same industry. Due to the committee's access to confidential information and heightened knowledge of case developments, many members view committee service as a way to sustain or strengthen the existing business relationship with the debtor and other committee members, who may provide vital business to the creditor.

Conclusion

While bankruptcy may connote worry and fear, the actual process can provide significant opportunities for the creditor solicited to serve on a committee. Although committee service requires a considerable time commitment accompanied with extensive responsibility, a creditor may find that they have excerpted more control in an environment where creditors often find themselves feeling somewhat helpless. Committee service should be seriously considered in consultation with counsel to discuss the advantages and disadvantages of committee service in a particular situation, but should always be considered.


Authored By:

Malani J. Cademartori

212.332.3847

mcademartori@sheppardmullin.com

]]> http://www.bankruptcylawblog.com/industry-focus-considerations-for-service-on-an-unsecured-creditors-committee.html http://www.bankruptcylawblog.com/industry-focus-considerations-for-service-on-an-unsecured-creditors-committee.html Industry Focus Tue, 14 Apr 2009 18:35:34 -0500 updates@antitrustlawblog.com (Sheppard Mullin) Tax Relief For Investment, Restructuring, Refinancing And Other Business Activity On February 17, 2009, President Obama signed the American Recovery and Reinvestment Tax Act of 2009 ("ARRTA").  ARRTA contains significant potential Federal income tax relief for businesses.  Some of the more important provisions are summarized in the remainder of this article.

]]>
  • Delayed Recognition of Debt Cancellation Income for Debt Repurchased, Replaced or Modified During 2009 or 2010. A corporation or business recognizes cancellation of debt income ("COD") when the taxpayer or a related party repurchases its debt for less than the amount outstanding or modifies or replaces the debt so it has a lower issue price.  ARRTA allows the COD to be deferred until 2014 and recognized over the next five years through 2019.  If deferral is elected, deductions for original issue discount ("OID") on direct or indirect replacement debt are similarly deferred.  COD so deferred is accelerated into income upon cessation of business, liquidation, or sale of all or substantially all the assets of the business (or the day before it files a bankruptcy petition) or, in the case of an S corporation or partnership, upon sale, exchange or redemption of an interest or death of a shareholder or member.
  • Temporary Allowance of Deductions for OID on Modification or Exchanges Into High-Yield Discount Obligations.  Corporations cannot deduct unpaid OID representing a yield higher than six percentage points over the applicable federal rate on debt with a term of 5 years or more.  ARRTA temporarily suspends this disallowance for exchanges or modifications after September 1, 2008 and before December 31, 2008, provided the old debt itself was not a high-yield discount obligation, does not have contingent interest, and is not held by a person related to the issuer.  Thus, such publicly traded debt can be exchanged without COD arising as a result of trading at a discount in the secondary market, and privately held debt can be modified debt so it has substantial OID without COD (such as due to deferring payments of interest).  IRS can temporarily use higher rates to determine high-yield discount status.
  • Extension of Bonus Depreciation and Increase in Small Business Expensing. Businesses can deduct for regular and alternative minimum tax ("AMT") purposes 50% of the cost of most depreciable tangible personal property, computer software, qualified leasehold improvements and certain other property acquired and placed in service during 2009 as well as during 2008.  Also, taxpayers can write-off immediately up to $250,000 of tangible personal property and computer software purchased during 2009, subject to phase out if such purchases exceed $800,000.
  • Extension of Election to Accelerate Pre-2006 AMT and Research Credits In Lieu of Bonus Depreciation. As under prior law, instead of bonus depreciation a corporation may elect to increase its limits on use of pre-2006 AMT and research credits up to the lesser of 6% thereof or $30 million.  Different elections for 2008 and 2009 are allowed.
  • Preservation of NOLs Following Ownership Changes Pursuant to Loans Under EESA. The limitation on using net operating losses ("NOLs") of a corporation after a more than 50% ownership change does not apply to a change required under a loan agreement or commitment with Treasury under the Emergency Economic Stabilization Act of 2008 to rationalize costs, capitalization and capacity with respect to manufacturing workforce of, and supplies to, the corporation, or to certain later ownership changes, provided the corporation is not more than 50% held by one or related persons (other than a voluntary employees benefit association).  IRS Notice 2008-83 is overturned for post‑January 16, 2009 deals not previously committed (Notice 2008-83 granted similar relief to banking institutions).
  • 5-Year Carryback of NOLs for Smaller Business. A business with average gross receipts up to $15,000,000 for its prior three years may elect to carry back five years any NOL for its taxable year beginning or ending in 2008.
  • Temporary Suspension of S Corporation 10-Year Built-In Gain Rule. S corporations that have not been C corporations for more than seven years can sell built-in gain assets during 2009 or 2010 without incurring corporate-level tax, rather than having to wait until more than 10 years after electing S corporation status.
  • Expansion of Qualified Small Business Stock Rule for Investments Before 2012. For qualified small business stock acquired after enactment and before 2012 and held five years, 75% rather than 50% of gain will be excluded.
  • Numerous Other Business Incentives. ARRTA includes numerous other incentives for business investment and activity, including credits for hiring veterans and disconnected youth, expansion of industrial development and other tax-exempt bond provisions, credits for renewable energy products and projects, and many other new tax benefits.

    • Authored by:

    John R. Bonn

    (978) 594-0170

    jbonn@sheppardmullin.com

    Pursuant to applicable Treasury Regulations, we notify you that the information in the foregoing flyer does not constitute legal or tax advice, cannot be used for the purpose of avoiding any tax penalties that may be imposed on any person, and may not be used or referred to in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to any person. No limitation is hereby imposed on disclosure of tax treatment or structure of any transaction.

    ]]>     http://www.bankruptcylawblog.com/other-nationally-significant-cases-tax-relief-for-investment-restructuring-refinancing-and-other-business-activity.html http://www.bankruptcylawblog.com/other-nationally-significant-cases-tax-relief-for-investment-restructuring-refinancing-and-other-business-activity.html Other Nationally Significant Cases Fri, 13 Feb 2009 17:01:19 -0500 updates@antitrustlawblog.com (Sheppard Mullin)     Shipping Industry Problems Most maritime shipping companies were operating profitably through the summer of 2008 until the "perfect storm" of the credit crisis and the worldwide recession struck, leading to the collapse of both the commodity and freight markets.  The resulting upheaval has affected trade credits, shipbuilding deliveries, orders, chartering, and sales-and-purchases, among other things, for shipping companies worldwide.  Reports of bankruptcy, insolvency, liquidation and complex debt restructurings of shipping and other maritime industry companies have begun surfacing in the trade press, with more to come.

    As a result of the turmoil in the shipping industry, actions seeking attachments under Supplemental Admiralty Rule B of the Federal Rules of Civil Procedure have risen dramatically, further exacerbating the problems facing cash-strapped shipping companies.  As the recent U.S. bankruptcy filings of Armada (Singapore) Pte. Ltd. and Atlas Shipping A/S demonstrate, Chapter 15 bankruptcy proceedings under the U.S. Bankruptcy Code may provide struggling shipping companies with a powerful tool for protecting their assets from Rule B Attachments.

    ]]> Rule B Attachments

    Under Rule B, a party may obtain security for a maritime claim that has not yet been reduced to judgment or arbitral award.  Rule B Attachments can be issued by the court where the action on the merits is pending or by any court where the defendant has assets so long as the defendant itself is not located or otherwise found in that jurisdiction.  Thus, while the type of claim must be within that court's admiralty jurisdiction (i.e., arising from a maritime tort or contract), the underlying dispute need not have any connection to the particular court's geographical district or even the United States.  In addition, a claimant can obtain a Rule B Attachment on an ex parte basis, without notifying its opponent in advance.  In fact, many shipping companies only learn their funds have been attached when a puzzled business partner inquires about a payment not received.

    Rule B Attachments are popular because they are effective.  In Winter Storm Shipping, Ltd. v. TPI, the Court of Appeals for the Second Circuit held a Rule B Attachment can intercept and attach an electronic funds transfer (EFT) in the hands of an intermediary bank, including the New York Clearing House banks in Manhattan that process virtually all transfers of U.S. currency (or USD transfers) made worldwide.  Because shipping industry transactions are generally in U.S. currency and usually pass through one of the New York Clearing House banks, Rule B Attachment proceedings have become exceptionally popular in the Southern District of New York (which includes Manhattan) where they now comprise approximately 30% of all new cases filed.

    Relief under U.S. Bankruptcy Law

    Foreign shipping companies facing financial difficulties or the threat of Rule B Attachment can protect themselves through the United States bankruptcy laws.  When a company files for bankruptcy certain automatic protections are triggered.  First, in most cases, the filing will act to suspend a debtor's past, pending and current liabilities and obligations, providing the debtor with opportunity and time to reorganize its business operations and financial arrangements, while allowing the debtor to continue to manage its business and maintain control of its assets and corporate governance, subject only to certain restrictions and the supervision of the bankruptcy court.  Second, upon a bankruptcy filing, the law imposes an automatic, statutory stay, which suspends the continuation or commencement of any action, proceeding or any other formal or informal attempt to recover claims against the debtor or its assets – anywhere in the world.  There are certain exceptions to the automatic stay and a creditor can request the court to grant relief from the stay.  Generally though, the protections of the automatic stay under the U.S. Bankruptcy Code will provide a debtor with breathing room and the ability to protect its assets during the proceeding, giving it time to catch its breath and, perhaps, chart a new course.

    Foreign companies can protect themselves through Chapter 15 of the Bankruptcy Code.  Although Chapter 15 does not commence a full-blown bankruptcy case within the United States, it can provide a foreign debtor in an insolvency proceeding outside of the United States with certain protections, including the automatic stay, to protect assets in the United States.  Specifically, a foreign shipping company that has commenced an insolvency proceeding abroad, may be able to stay all actions against it, including pending Rule B Attachments, by filing a Chapter 15 case soon after the commencement of its foreign proceedings.  The Board of Directors of Armada (Singapore) Pte. Ltd. recently filed a chapter 15 petition in the Bankruptcy Court for the Southern District of New York for recognition of the company's insolvency proceeding in Singapore, for exactly that reason – to protect its assets against potential Rule B Attachments.

    To qualify for protection under Chapter 15 of the Bankruptcy Code, a foreign debtor's authorized foreign representative must file a petition for recognition of the foreign insolvency proceeding, meet certain statutory requirements, notify all relevant parties and attend a hearing for approval of such recognition.  A foreign representative can also seek provisionally to stay any execution or action against the debtor's assets from the time it files a petition for recognition through the time when the Bankruptcy Court makes its decision whether or not to approve the recognition of the foreign proceeding.  If approved, the Bankruptcy Court will enter an order recognizing the foreign proceeding either as a "foreign main proceeding," if the foreign proceeding is pending in the country where the debtor has its main interests, or as a "foreign non-main proceeding," if the foreign proceeding is pending in a country where the debtor has a place of operations to carry out non-transitory economic activity.  The scope of protections afforded to a foreign debtor will differ depending on whether the court determines the foreign proceeding to be a main or non-main proceeding.  Specifically, the automatic stay against all proceedings applies only upon the recognition of a foreign main proceeding.  Alternatively, while the recognition of a foreign non-main proceeding does not trigger the general automatic stay, it does grant the Bankruptcy Court the power to stay the commencement or continuation of individual or specific actions against the debtor's assets, and to suspend the right to transfer, encumber or otherwise dispose of the debtor's property and assets within the United States. 

    No one is yet certain where the shipping industry is headed or the extent of the damage that has been done.  In the midst of this uncertainty, United States bankruptcy law may provide some needed relief to enable shipping companies to reorganize.

    Authored by:

    Edward H. Tillinghast, III
    (212) 332-3529 - etillinghast@sheppardmullin.com

    Greggory B. Mendenhall
    (212) 332-3825 - gmendenhall@sheppardmullin.com

    Charles S. Donovan
    (415) 774-2994 - cdonovan@sheppardmullin.com

    Elizabeth Rotenberg-Schwartz
    (212) 332-3800 - erotenberg-schwartz@sheppardmullin.com

    Malani J. Cademartori
    (212) 332-3847 - mcademartori@sheppardmullin.com

    Blanka Wolfe
    (212) 332-3822 - bwolfe@sheppardmullin.com

    ]]>     http://www.bankruptcylawblog.com/industry-focus-shipping-industry-problems.html http://www.bankruptcylawblog.com/industry-focus-shipping-industry-problems.html Industry Focus Mon, 09 Feb 2009 11:03:37 -0500 updates@antitrustlawblog.com (Sheppard Mullin)     Dealing With Troubled Companies - Does Purchasing Assets Avoid Seller Liabilities? A common strategy for acquiring the business of a troubled company is to purchase assets rather than acquire all outstanding capital stock of the target, based on the general principle that a purchaser of assets is not responsible for liabilities of its seller absent an express or implied assumption.  Does the strategy work?  Depending on the liability and circumstances, the answers are "No" and "Maybe," and sometimes a qualified "Yes."  In troubled economic times, buyers may reconsider whether they are willing to rely upon indemnity by the seller or its owners, particularly since doctrines of public policy may render such an indemnity unenforceable in certain situations.

    ]]>
  • State and Local Taxes.  At least 25 of the 50 states impose successor liability on a purchaser of assets with respect to unpaid taxes of the seller, unless the purchaser either (i) withholds the taxes from the purchase price or (ii) obtains a clearance certificate from the government.  Usually, but not always, the transaction must involve substantially all the assets of the business or a termination of business by the seller.
  • Bulks Sales Act.  Failure to comply with a state bulk sales act, if applicable, generally results in liability for the purchaser to creditors of the seller.
  • Certain Product Liabilities.  A buyer may inherit seller product liabilities pursuant to judicial doctrine.
  • Collective Bargaining Agreements.  A purchaser of assets may be required to recognize and bargain with a union that represented the seller's employees
  • Certain Underfunded Pensions. If the seller participates in an underfunded multiemployer union pension plan, a sale of its assets results in immediate withdrawal liability.  Some courts hold a buyer liable for a seller's delinquent contributions and withdrawal liability despite disclaimer in the asset purchase agreement.
  • Environmental Liabilities. A buyer may be liable for seller liabilities under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 or other environmental laws.
  • Regulated Industries. If the seller engages in a business subject to special governmental regulation, then additional issues arise concerning potential exposure of an asset purchaser to seller liabilities.
  • De Facto Merger or "Mere Continuation" of Seller. Pursuant to common law developed by the courts, a seller and buyer may be considered to have undergone a "de facto merger" or the buyer may be considered a "mere continuation" of the seller, with the result that the buyer is liable to creditors of the target.
  • Fraudulent Transfers. Obviously an actually fraudulent sale can create successor liability.  However, both state and federal law may treat a transfer as "fraudulent" -- and thereby expose the buyer to liabilities of its seller –in various circumstances, most commonly where the seller is insolvent before or after the transfer.

    • Authored by:

    John R. Bonn

    (978) 594-0170

    jbonn@sheppardmullin.com

    ]]>     http://www.bankruptcylawblog.com/industry-focus-dealing-with-troubled-companies-does-purchasing-assets-avoid-seller-liabilities.html http://www.bankruptcylawblog.com/industry-focus-dealing-with-troubled-companies-does-purchasing-assets-avoid-seller-liabilities.html Industry Focus Tue, 27 Jan 2009 19:50:28 -0500 updates@antitrustlawblog.com (Sheppard Mullin)     When Red is the Color of the Season: Commercial Property Leases and Bankruptcy Bankruptcy filings are skyrocketing as more and more companies are going deep into the red.  For retailers or their landlords holding leases in commercial property, there are special considerations to keep in mind.  This post will provide some basic information on the rights of non-debtor tenants and landlords under unexpired non-residential property leases when a debtor–landlord or –tenant, respectively, files a chapter 11 bankruptcy petition.

    ]]> Assuming or Rejecting the Lease.  When a debtor files for bankruptcy and seeks to reorganize its business under chapter 11, the debtor will generally retain possession of its property and continue to manage its business as a debtor in possession.  The debtor has broad rights to either assume, assume and assign, or reject commercial leases (and other contracts and leases to which it may be a party), subject only to court approval.  By assuming a lease, the debtor is choosing to continue under the terms of the lease and accepts all burdens and obligations related to the lease.  If rejected, however, the debtor will be relieved of its obligations under the lease, leaving the non-debtor with an unsecured claim for damages based on a breach of the lease.

    When the chapter 11 debtor is the tenant:

    • Before a tenant-debtor may assume an unexpired lease of non-residential real property, it must: (1) cure any monetary defaults, or provide adequate assurance that any monetary defaults under the lease will be promptly cured; and (2) provide adequate assurance that all obligations under the lease will be satisfied in the future.  For tenant-debtors seeking to assume a lease in a shopping center, additional showings are required for adequate assurance of future performance, including evidence of the source of rent and assurances that any percentage rent due will not decline substantially.
    • If the tenant-debtor rejects the lease of non-residential real property, the tenant will be required to immediately vacate the premises.  In addition, the rejecting tenant-debtor will still be required to address any claims made against it for past due and unpaid rental and other monetary obligations, and may be exposed to damages for rejection of such lease, including future rent.

    When the chapter 11 debtor is the landlord:

    • Similarly, if a landlord-debtor assumes an unexpired lease of non-residential real property, it must first: (1) cure any monetary defaults, or provide adequate assurance that any monetary defaults under the lease will be promptly cured; and (2) provide adequate assurance that all obligations under the subject lease will be satisfied in the future.
    • However, if a landlord-debtor rejects an unexpired lease of non-residential real property, the non-debtor tenant will have the option to treat the lease as terminated or retain its rights under the lease for the duration of the lease and any renewal or extension periods thereof.  The landlord-debtor must allow the tenant to exercise its rights, including with respect to the amount and timing of payment of rent and any other amounts due, and to possession, use, quiet enjoyment, subletting, assignment and hypothecation.  If the non-debtor tenant opts to remain, the landlord-debtor is not required or obligated to actively perform their duties and responsibilities under such lease.  The tenant, however, is entitled to offset any damages incurred by the tenant by virtue of the landlord-debtor's non-performance of its obligations under the lease against the rental or other payments it is required to make.  Rejection of a lease of non-residential real property in a shopping center where the non-debtor tenant opts to continue its use of the premises will not affect the enforceability of any provision pertaining to radius, location, use, exclusivity, tenant mix or balance within the shopping mall.
    • In the event that either a tenant-debtor or landlord-debtor seeks to assume and assign a lease of non-residential real property to a third party: (1) the debtor party must still first cure any monetary defaults, or provide adequate assurance that any monetary defaults under the lease will be promptly cured; and (2) the proposed third-party assignee must provide adequate assurance of its future performance under such lease from and after assignment.  In addition, before a shopping center lease is assigned to a third party, the proposed assignee must provide adequate assurance that it is able to perform under the lease, including compliance with all restrictive covenants and the ability to maintain the tenant mix or balance within the shopping center will not be disturbed.

    Timeframe.  In 2005, Congress reduced the time in which a tenant-debtor may assume, assume and assign, or reject an unexpired lease of non-residential real property to 120 days of the bankruptcy filing.  The debtor may be granted one 90-day extension of this 120-day period, however, if the tenant-debtor wishes to seek further extensions thereafter, it must first attain written approval of the non-debtor landlord.  If assumption has not occurred within the required time period, the unexpired lease is deemed rejected.

    This 210 day cap has significant implications for retail debtors.  Prior to this change the time to make a decision for assumption or rejection was often virtually unlimited (and remains virtually unlimited for landlord-debtors), allowing a retailer to evaluate sales at a particular store for one, if not two, holiday seasons.  Now, the decision must be made within seven months.

    Assignment of Leases.  Many leases have provisions purporting to restrict or prohibit assignment (as well as provisions which state that the lease will terminate upon bankruptcy).  There are, however, specific Bankruptcy Code sections which render such provisions generally unenforceable in the bankruptcy context.

    The ability to assign a non-residential real property lease can provide a significant opportunity to retail debtors who hold leases below market rates and are able to find third-party buyers to purchase the rights under, and thereby take over, these leases.  This not only provides proposed assignees with an opportunity to step into the shoes of the debtor on below-market unexpired commercial leases, but also provides the retail tenant-debtors with additional capital with which to administer their estates.  Note that with respect to shopping center leases, limitations such as radius, location, use, or exclusivity will continue to be enforceable, even in the bankruptcy context.

    If the Debtor is a Sublandlord.  If you are a tenant under a sublease and the sublandlord files for bankruptcy, your right to occupy the property will likely be terminated if the sublandlord rejects the master lease (the lease between the ultimate landlord and your sublandlord).  You may retain your rights to possess the property, however, if you have a non-disturbance agreement with the ultimate landlord or if you are a third party beneficiary of a non-disturbance clause in the master lease.

    Get prompt legal advice. Whether the debtor is a tenant or a landlord, commercial leases will be affected by any bankruptcy proceeding. The above discussion provides only a brief snapshot of the complexities involved when a business holding commercial leases as either a landlord or debtor files for bankruptcy. In order to protect your rights, get prompt legal advice any time bankruptcy proceedings are involved.

    Authored by:

    Richard Brunette

    (213) 617-4174

    rbrunette@sheppardmullin.com

    and

    Kristy E. Young

    (415) 774-3153

    kyoung@sheppardmullin.com

    ]]>     http://www.bankruptcylawblog.com/industry-focus-when-red-is-the-color-of-the-season-commercial-property-leases-and-bankruptcy.html http://www.bankruptcylawblog.com/industry-focus-when-red-is-the-color-of-the-season-commercial-property-leases-and-bankruptcy.html Industry Focus Fri, 12 Dec 2008 15:48:01 -0500 updates@antitrustlawblog.com (Sheppard Mullin)     Actions Taken In Violation Of The Automatic Stay Are Void... Sometimes In Burkhart v. Coleman, (In re Tippett) --- F.3d ---, 2008 WL 4070690 (9th Cir. Sept. 4, 2008), the Ninth Circuit held that an unauthorized post-petition sale of real property may be upheld where: 1) the bankruptcy trustee failed to record the bankruptcy petition with the county recorder; and 2) a bona fide purchaser thereafter bought and recorded title in the property.  As welcome as this news is to bona fide purchasers in California, the opinion raises interesting issues pertaining to acts arguably taken in violation of the automatic stay under section 362 of the Bankruptcy Code by holding that the automatic stay may not apply to sales or transfers of property initiated by the debtor under certain circumstances.

    ]]> Mr. and Mrs. Tippett filed a Chapter 7 petition in May of 2001.  On their schedules, the Tippetts listed their homestead as having a value of $140,000, with two liens against it totaling approximately $135,000.  The bankruptcy Trustee did not abandon the bankruptcy estate's interest in the residence, but did not record the Tippetts' petition with the county recorder.  

    Without obtaining bankruptcy court approval, in November of 2002, the Tippetts sold their home to Seitu Coleman for $225,000.  This sale resulted in the receipt by the Tippetts of over $75,000 after payment of all liens on the property.  To purchase the property, Coleman signed purchase money notes in favor of two mortgage companies.  These notes were secured by deeds of trust that were duly recorded.  It was undisputed that Coleman was a bona fide purchaser of the property. 

    The Trustee filed an adversary proceeding against the Tippetts, Coleman, and the lenders seeking to recover the sale proceeds under 11 U.S.C. § 542, avoid the lenders' liens, and quiet title to Coleman.  The bankruptcy court, however, ruled in favor of the Trustee, and held that the Tippetts' grant deed and the lenders' liens were void ab initio as violations of the automatic stay under 11 U.S.C. § 362.  On appeal, the Bankruptcy Appellate Panel reversed and entered judgment in favor of Coleman, concluding that the Tippetts' unauthorized transfer of the residence to Coleman did not violate the automatic stay.

    The Ninth Circuit affirmed the BAP decision and held that the Bankruptcy Code does not preempt California's bona fide purchaser status as it applied to the foregoing transaction.  Additionally, the Court held it was "adher[ing] to the established proposition that the automatic stay triggered by a debtor's bankruptcy petition does not void transfers of estate property initiated by the debtor." 

    Preemption

    The Ninth Circuit found that California's Bona Fide Purchaser Statute was not preempted by the Bankruptcy Code.  In making this determination, the Court found that Chapter 7 of the Code embodies two ideals: 1) giving a debtors a fresh start, and 2) equitably distributing a debtor's assets among competing creditors.  The Court found that California's bona fide purchaser statute was "wholly consistent" with the second goal, and thus there was no federal preemption. 

    The Automatic Stay

    The Trustee also contended that the automatic stay rendered the transfer of the real property to Coleman a nullity pursuant to 11 U.S.C. § 362.  This argument would appear to persuasive as the Ninth Circuit has consistently stated that violations of the automatic stay are void, not merely voidable.  However, the Court in In re Tippett concluded otherwise. 

    The Court's rationale was as follows: section 549 of the Bankruptcy Code, allows (but does not mandate) a trustee to avoid a transfer of property of the estate that occurs post-petition and without authorization.  According to the Bankruptcy Court, the expansive definition of "transfer" in section 549 means that sections 362 and 549 of the Bankruptcy Code, at times, govern the same transactions.  In addition, section 549 of the Bankruptcy Code implies that some transactions will be valid unless challenged by a trustee.  Thus, the Court noted that some have argued section 362 of the Bankruptcy Code cannot be interpreted to void these overlapping transactions, for doing so would render section 549 of the Bankruptcy Code moot. 

    The Court also found that there was a key difference between section 549 and section 362: section 362 protects the debtor, not creditors, while section 549 is designed to protect creditors against unauthorized transfers by the debtor.  Moreover, the Court cited Schwartz v. United States (In re Schwartz), 954 F.2d 569, 574 (9th Cir. 1992), for the proposition that in most circumstances, section 549 applies to transfers in which the debtor is a willing participant; in contrast, the automatic stay under section 362 does not apply to sales or transfers of property initiated by the debtor.  As a result, the transfer from the Tippetts to Coleman was not rendered void by the automatic stay. 

    Unfortunately, the Court does not provide any analysis as to why section 362 does not apply to sales or transfers of property initiated by the debtor.  Rather, the Court found itself bound by the principles of stare decisis, and concluded that "there is no question that the analysis and conclusion in Schwartz that the automatic stay did not apply to transfers by debtors was an important and focused part of the panel’s reasoning."  The "analysis" in Schwartz, however, is non-existent, and Schwartz fails to include a single case in support of this proposition. 

    As a result, the few short paragraphs in the opinion that discuss the automatic stay add a further wrinkle to the well established Ninth Circuit authority that renders actions taken in violation of the automatic stay as "void," at least when the debtor is the one initiating the action.  Although it is clear from reading the opinion that the automatic stay does not apply to transfers by debtors, at least under certain circumstances, the rationale for this proclamation is uncertain. As a result, it is unclear how future cases will apply section 362 if it involves transfers by the debtor. 

    If In re Tippett is held to its facts, the potential impact on the Ninth Circuit's interpretation of the automatic stay may be quite limited.  However, the possibility that In re Tippett could be extended beyond its particular facts is one that creditor and debtor attorneys should be aware of.

    Authored by:

    Stephanie M. Seidl

    (213) 617-4177

    sseidl@sheppardmullin.com

    ]]>     http://www.bankruptcylawblog.com/9th-circuit-caselaw-actions-taken-in-violation-of-the-automatic-stay-are-void-sometimes.html http://www.bankruptcylawblog.com/9th-circuit-caselaw-actions-taken-in-violation-of-the-automatic-stay-are-void-sometimes.html 9th Circuit Caselaw Thu, 02 Oct 2008 15:52:13 -0500 updates@antitrustlawblog.com (Sheppard Mullin)     United States Supreme Court Resolves Circuit Split In a recent decision, the United States Supreme Court ruled that asset sales in bankruptcy that occur after plan confirmation will be exempt from certain and often potentially costly state taxes, whereas sales that occur before plan confirmation will not be so exempt. In so ruling, the Court resolved a circuit split regarding the meaning of the statutory phrase "under a plan confirmed under [Chapter 11] of the bankruptcy Code," as codified in 11 U.S.C. § 1146(a).

    The case arose from the bankruptcy of Piccadilly Cafeterias, Inc.  At one time among the nation's most successful cafeteria chains, Piccadilly had fallen on hard financial times.  In 2003, Piccadilly filed for Chapter 11 bankruptcy protection in the Southern District of Florida.  As the centerpiece of its reorganization efforts, Piccadilly sought court authorization to sell virtually all of its assets in a § 363(b)(1) sale pursuant to a settlement agreement reached with creditors.  The bankruptcy court granted this authority.  In authorizing the sale, the bankruptcy court further ruled Piccadilly's transfer of assets would be "exempt from stamp taxes under § 1146(a)."  (Maj. Slip Op. at 2.)  Piccadilly closed its sale on March 16, 2004.

    ]]> Months after the successful sale, Piccadilly filed a plan of reorganization.  On July 31, 2004, Piccadilly filed its second amended (and final) plan of reorganization.  The plan duly called for a transfer of assets "in a manner consistent with" the sale that had closed in March.

    The Florida Department of Revenue objected to the plan.  Seeking payment of $39,200 in stamp taxes it had assessed against some of Piccadilly's transferred assets, Florida argued the transfer had not been "under a plan confirmed."  11 U.S.C. § 1146(a).  Florida's argument was simple.  The statutory term "confirmed," because it is a past participle, refers exclusively to something that has already happened.  But at the time of the transfer, plan confirmation had not yet occurred.  Therefore, the transfer had not been "under a plan confirmed" and thus fell outside the scope of the § 1146(a) tax exemption.  Piccadilly countered that "under a plan confirmed" imposed no such temporal requirement.  According to Piccadilly, the most natural reading of the statute extended the exemption to all transfers that complied with the terms of a plan, regardless of whether that plan's confirmation happened before, or after, the transfer.

    On cross-motions for summary judgment, the bankruptcy court ruled in favor of Piccadilly.  The District Court for the Southern District of Florida affirmed.  The Court of Appeals for the Eleventh Circuit also affirmed in a per curiam opinion.  Noting a circuit split, the Supreme Court granted certiorari.

    In a vote of 7-2, with Thomas, J., speaking for the majority and Breyer, J., writing in dissent, the Court reversed and remanded:

    The most natural reading of § 1146(a)'s text, the provision's placement in the Code, and applicable substantive canons of all lead to the same conclusion: Section 1146(a) affords a stamp-tax exemption only to transfers made pursuant to a Chapter 11 plan that has been confirmed.  Because Piccadilly transferred its assets before its Chapter 11 plan was confirmed by the Bankruptcy Court, it may not rely on § 1146(a) to avoid Florida's stamp taxes.

    (Maj. Slip Op. at 19.)  To reach its conclusion, the Court relied principally on the text.  Section 1146(a) provides, in its entirety:

    The issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under section 1129 of this title, may not be taxed under any law imposing a stamp tax or similar tax.

    11 U.S.C. § 1146(a).  Acknowledging the variability of the term "under," the Court nevertheless found the statute's meaning was plain.  "Confirmed," the Court observed, is a past participle.  As such, it is most naturally interpreted as referring to something that has already occurred.  Therefore, the plain terms of § 1146(a) extends the stamp tax exemption only to transfers made under a plan that has already been confirmed.

    The Court then continued on to hold that even if § 1146(a)'s text was ambiguous, nothing suggested the Court should resolve that ambiguity in favor of Piccadilly.  Indeed, the Court held that in the event of ambiguity, the interpretive "canon" of California State Bd. of Equalization v. Sierra Summit, Inc., 490 U.S. 844 (1989), required it to construe the provision narrowly in favor of state taxing authorities.

    Writing in dissent, Breyer and Stevens, JJ., set forth a three-step critique.  First, the dissent argued, the notoriously variable term "under"—past participles notwithstanding—rendered the statute ambiguous.  Second, the dissent doubted the applicability of the Sierra Summit canon.  Specifically, the dissent wondered how this so-called canon could logically apply to a provision "the express point of which is to exempt some category of state taxation?"  (Dissent Slip Op. at 3.)  Third, the dissent concluded that because the statute was ambiguous, and because Sierra Summit should not apply, the Court should construe the statute in light of Chapter 11's basic objectives: (1) preserving going concerns and (2) maximizing property available to satisfy creditors.

    These objectives, the dissent urged, militate in favor of the exemption.  For one thing, the Chapter 11 plan confirmation process "takes time" (Dissent Slip Op. at 5), whereas asset sales are sometimes most successful when the debtor closes them relatively early.  Among other things, restricting the tax exemption to only those debtors who close a sale after confirmation would potentially reduce the incentive to engage in a timely sale process and may have a chilling effect on the ability of a debtor to market its assets and maximize their value, thus subverting the purposes of Chapter 11 to the detriment of the bankruptcy estate and creditors.

    ]]>     http://www.bankruptcylawblog.com/other-nationally-significant-cases-united-states-supreme-court-resolves-circuit-split.html http://www.bankruptcylawblog.com/other-nationally-significant-cases-united-states-supreme-court-resolves-circuit-split.html Other Nationally Significant Cases Wed, 09 Jul 2008 18:36:26 -0500 updates@antitrustlawblog.com (Sheppard Mullin)     Relief for Securitization Vehicles: Mortgage Modification under Foreclosure Prevention Programs 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:

    ]]> (1) The real property securing the mortgage loan is a residence that contains fewer than 5 dwelling units.

    (2) The real property securing the mortgage loan is owner-occupied.

    (3) If a REMIC holds the mortgage loan, then as of either the startup day or the end of the 3-month period beginning on the startup day, no more than 10% of the stated principal of the total assets of the REMIC was represented by loans the payments on which were then overdue by 30 days or more; and if an investment trust holds the mortgage loan, then as of all dates when assets were contributed to the trust, no more than 10% of the stated principal of all the debt instruments then held by the trust was represented by instruments the payments on which were then overdue by 30 days or more.

    (4) The holder or servicer reasonably believes that there is a significant risk of foreclosure of the original loan based on guidelines developed as part of a foreclosure prevention program similar to that described in the Revenue Procedure or may be based on any other credible systematic determination.

    (5) The terms of the modified loan are less favorable to the holder than were the unmodified terms of the original mortgage loan.

    (6) The holder or servicer reasonably believes that the modified loan presents a substantially reduced risk of foreclosure, as compared with the original loan.

    The Revenue Procedure applies generally to loan modifications that are effected on or before December 31, 2010.

    Authored by:

    D. Matthew Richardson

    (213) 617-4222

    mrichardson@sheppardmullin.com

    ]]>     http://www.bankruptcylawblog.com/other-nationally-significant-cases-relief-for-securitization-vehicles-mortgage-modification-under-foreclosure-prevention-programs.html http://www.bankruptcylawblog.com/other-nationally-significant-cases-relief-for-securitization-vehicles-mortgage-modification-under-foreclosure-prevention-programs.html Other Nationally Significant Cases Thu, 22 May 2008 18:30:12 -0500 updates@antitrustlawblog.com (Sheppard Mullin)     Seventh Circuit finds that Issuer of Fairness Opinion Did Not Commit Gross Negligence 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.

    ]]> In 1999, HALO agreed to acquire the stock of Starbelly for between $70 to $100 million cash and $140 to $170 million in HALO stock.  However, because HALO did not have the cash on hand and would violate certain covenants in HALO's loan agreement if it consummated the proposed transaction, HALO hired CSFB to renegotiate the price and issue a fairness opinion for HALO in connection therewith.  On January 17, 2000, CSFB issued the fairness opinion, which did not indicate whether CSFB was successful in attempting to renegotiate the purchase price, and concluded that from a financial point of view, the consideration to be paid by HALO for the stock of Starbelly was fair.  Both CSFB's engagement letter and its fairness opinion stated explicitly that CSFB relied on HALO's financial projections.  CSFB did not undertake to verify the projections.  Separately, HALO hired Ernst & Young ("Ernst") as a business consultant to evaluate the accuracy of the financials and the projections. Ernst concluded that HALO's projections were unrealistic, and communicated that conclusion to HALO's CEO and board of directors.  The HA2003 opinion does not indicate whether CSFB knew of Ernst's conclusion, and if so, when CSFB learned of the conclusion.

    The proxy solicitation sent to shareholders for approval of the stock acquisition included CSFB's fairness opinion, and investors approved the transaction, which then closed in May 2000.  Shortly after the transaction closed, HALO fell into financial distress as a result of the cash drain from the acquisition and Starbelly's continuing losses.  HALO filed bankruptcy in July 2001, and a liquidating trust was appointed.  

    Under CSFB's engagement letter with HALO, CSFB is liable only for bad faith or gross negligence. The liquidating trust sued CSFB for gross negligence based on CSFB's issuance of the fairness opinion. The arguments of the parties and Court's conclusion were as follows:

    The Trust's Arguments Why CSFB Was Grossly Negligent:

    ·     CSFB should have relied on Ernst's conclusion, rather than HALO's projections.

    ·     CSFB should have withdrawn the fairness opinion, or issued a new one, after the market price for dot-com stocks began to decline.

    ·     After CSFB issued the fairness opinion, but before the transaction closed, "any fool" could have seen that the purchase price should have been much lower.

    CSFB's Arguments Why It was Not Grossly Negligent:

    ·     CSFB could not predict what would happen in the market.  In fact, in mid-March 2000, two months after CSFB issued the fairness opinion, the market peaked.

    ·     If "any fool" could have seen that prices should be much lower, then no one could have possibly relied on the fairness opinion.

    ·     When the transaction closed, the market was at the same level as when the deal between HALO and Starbelly had been negotiated.

    ·     HALO and CSFB had agreed that CSFB would issue one fairness opinion, as of a certain date, not multiple or revised opinions.  Moreover, CSFB could not distinguish between short-term and long-term reverses in the market.  Carrying the Trust's argument to its logical conclusion, CSFB would have been required to issue a new opinion every time the market shifted.

    ·     In April 2000, a major HALO shareholder asked HALO management to seek a new valuation of Starbelly and an update of the fairness opinion.  HALO management chose not to do so.

    ·     The engagement letter between CSFB and HALO required CSFB to use the information provided by HALO. This was consistent with the industry norm.

    ·     CSFB told HALO to hire someone to check the numbers.

    ·     It was HALO that chose to go forward undaunted after receiving Ernst's conclusion.  HALO cannot blame that on CSFB just because CSFB is a deep pocket.

    The Seventh Circuit, adopting CSFB's arguments, ruled in favor of CSFB, concluding that CSFB had not acted grossly negligent.  

    The Seventh Circuit's opinion did not indicate if and when CSFB learned about Ernst's opinion, which arguably is a significant fact.  While the court was probably correct that it makes sense to have different entities verify the numbers (Ernst) and crunch the numbers (CSFB) because specialists should "do what they are best at", it probably also makes sense to have those entities communicate with each other so that everyone has full information.  If CSFB learned of Ernst's conclusion before CSFB issued its fairness opinion, such fact might warrant a different outcome. While CSFB might not have been required to verify the numbers, it seems that if CSFB knew the numbers were suspect, it should not be able to ignore that fact.  On the other hand, the HA2003 opinion implies that anyone deciding to invest in or approve the transaction should have known that HALO's projections were speculative, suggesting that Ernst's conclusion may not have provided information that people could not figure out for themselves.  In other words, anyone investing in or voting to approve such a transaction inherently must assume the business risks associated with that transaction.

    Authored by:

    Theodore A. Cohen

    (213) 617-4237

    tcohen@sheppardmullin.com

    ]]>     http://www.bankruptcylawblog.com/other-nationally-significant-cases-seventh-circuit-finds-that-issuer-of-fairness-opinion-did-not-commit-gross-negligence.html http://www.bankruptcylawblog.com/other-nationally-significant-cases-seventh-circuit-finds-that-issuer-of-fairness-opinion-did-not-commit-gross-negligence.html Other Nationally Significant Cases Thu, 06 Mar 2008 15:24:36 -0500 updates@antitrustlawblog.com (Sheppard Mullin)     Court Orders Case Transferred From New York To California 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.

    ]]> Background

    Dunmore California, a California corporation which was wholly owned by Sidney Dunmore, a California resident, and predecessor to the Debtor, was in the business of, among other things, land development and construction of single family homes throughout Northern and Central California.  The financial condition of Dunmore California began to deteriorate in September 2005, and by August 1, 2007, Dunmore California and its subsidiaries had halted nearly all home construction, land development operations and sales.  Shortly thereafter, Dunmore California sold all of its assets to the Debtor.  As part of that transaction, the Debtor also assumed virtually all of the liabilities of Dunmore California.  Fifty-nine days after the sale, on November 8, 2007, the newly formed Debtor, Dunmore Homes filed for bankruptcy relief under chapter 11 in the Southern District of New York.

    The Debtor, a New York corporation, is wholly owned by Michael Kane, a California resident, and has no offices, employees or bank accounts in New York.  All of its subsidiaries (none of which has filed for protection under the Bankruptcy Code) are located in California.  The Debtor's only connection to New York was its incorporation in New York fifty-nine days before the bankruptcy filing.

    Among other debts, the Debtor had significant indirect liabilities resulting from its assumed obligations as guarantor or co-borrower on the secured debt of its various California subsidiaries, which totaled approximately $195 million as of the date of filing.  The security for this debt is California real property owned at the subsidiary level.  Moreover, twenty-four of the Debtor's top thirty creditors are located in California, seven of whom joined the Motion and represent approximately $23,578,998.46 of the Debtor's debt.  The two bank creditors who opposed the Motion represent about $56,700,000 of the Debtor's debt.  It was undisputed that the vast majority of creditors below the top thirty are trade creditors located in California.

    Motion for Change of Venue

    The motion for change of venue sought transfer based on consideration of the interests of justice under 28 U.S.C. § 1412, and not that venue was improper under 28 U.S.C. § 1408, which entitles the Debtor to file its petition in the Southern District of New York because it is "domiciled" in New York.  Since the  issue of whether venue was proper under 28 U.S.C. § 1408 was only raised in a reply brief by one of the movants, the Court would not consider the issue and assumed venue was proper under 28 U.S.C. § 1408.  Under section 1412, the Court has discretionary power to transfer a case if the transfer would be in the best interest of justice or for the convenience of the parties.

    In considering whether the case should be transferred in the interest of justice, the court considers whether (i) transfer would promote economic and efficient administration of the bankruptcy estate, (ii) the interests of judicial economy would be served by the transfer, (iii) the parties would be able to receive a fair trial in each of the possible venues, (iv) either forum has an interest in having the controversy decided within its borders, (v) the enforceability of any judgment would be affected by the transfer and (vi) the debtor's original choice of forum should be disturbed.  In considering the convenience of the parties, the court looks at six factors: (i) proximity of creditors of every kind to the court, (ii) proximity of the debtor, (iii) proximity of witnesses necessary to the administration of the estate, (iv) location of the assets, (v) economic administration of the estate and (vi) necessity for ancillary administration if liquidation should result.

    After a careful analysis of all of those factors, the Court found that a transfer of venue was appropriate because, among other things, "the thin nexus of the Debtor to the Southern District of New York, and the overwhelming contacts between the Debtor and Eastern District of California, combined with no overriding factors making it substantially more likely that the Debtor's prospects for a successful reorganization would be enhanced if this Court were to retain jurisdiction, raise serious questions whether the Court would abuse its discretion if it denied the motion to transfer venue in the interests of justice."  In re Dunmore Homes, Inc., No. 07-13533 (MG), slip op. at 20 (S.D. N.Y. Jan. 14, 2008).

    The Court found that where the Debtor's connections, including the majority of a Debtor's creditors and contacts, were in California, which could create, among other things, geographical hardships on the parties involved, the Court would exercise its discretion to grant the Motion and transfer the bankruptcy case to California.

    Authored by:

    Mary Johnson

    (212) 332-3525

    mjohnson@sheppardmullin.com

    ]]>     http://www.bankruptcylawblog.com/other-nationally-significant-cases-court-orders-case-transferred-from-new-york-to-california.html http://www.bankruptcylawblog.com/other-nationally-significant-cases-court-orders-case-transferred-from-new-york-to-california.html Other Nationally Significant Cases Fri, 01 Feb 2008 15:10:16 -0500 updates@antitrustlawblog.com (Sheppard Mullin)