One person’s successful confirmation of a plan of reorganization is another person’s bad faith abuse of the rules. Last month in In re The Village at Lakeridge, LLC, the Ninth Circuit Court of Appeals waded into just such an area: the intersection of claims buying, insider status, and plan voting. Specifically, it addressed whether a non-insider creditor who purchases a claim from an insider is considered an insider for voting purposes. While it is well-settled that an insider’s vote is not counted for confirmation purposes under § 1129(a)(10), it was an open question, at least in the Ninth Circuit, whether insider status follows the insider claim’s in the hands of a non-insider purchaser. This is an important confirmation issue, especially in close cases where every vote matters.

Facts of the Case

The Debtor had two primary creditors: U.S. Bank, which held a $10 million fully-secured claim, and MBP Equity Partners 1, LLC (the Debtor’s sole member), which held a $2.76 million unsecured claim. MBP’s board decided to sell its claim shortly after the Debtor filed its disclosure statement and plan of reorganization. One of MBP’s board members, Katie Bartlett, approached a personal friend, Dr. Robert Rabkin. Ultimately, she negotiated a sale of MBP’s $2.76 million claim to Dr. Rabkin for a mere $5,000.00. U.S. Bank challenged the sale on a number of grounds, including bad faith.

On that issue, Ms. Bartlett testified that MBP sold the claim for two reasons: (1) the insider claim was useless to MBP for voting purposes and (2) a sale might be tax-advantageous. And Dr. Rabkin testified that he had little knowledge of the Debtor or MBP but had a close business and personal relationship with Ms. Bartlett. He also testified that he purchased the claim as a business investment. U.S. Bank offered at the deposition to purchase the claim from Dr. Rabkin for $50,000.00. It then increased its offer to $60,000 when Dr. Rabkin asked for time after his deposition to consider. Rabkin never responded to the offer.

Lower Court Rulings

Based on the testimony, U.S. Bank moved to designate Dr. Rabkin’s claim and disallow it for plan voting purposes. First, U.S. Bank characterized Dr. Rabkin as either a statutory or a non-statutory insider on account of the purchase. Second, it argued that MBP sold the claim to Dr. Rabkin in bad faith. Although the Bankruptcy Court disagreed with U.S. Bank on those 2 points, it did find that Dr. Rabkin became a statutory insider. The theory: When a statutory insider (MPB) sells or assigns a claim to a non-insider (Dr. Rabkin), the non-insider becomes a statutory insider as a matter of law.

On direct appeal, the Ninth Circuit Bankruptcy Appellate Panel agreed that (i) Dr. Rabkin was not a non-statutory insider and (ii) that MBP had not assigned the claim in bad faith. However, it reversed Bankruptcy Court’s holding that the statutory insider status traveled to Dr. Rabkin via the claim assignment.

Ninth Circuit Ruling

The Ninth Circuit, with one judge dissenting, agreed with the BAP.

First, it rightly emphasized the distinction under the Code between the status of a claim and status of a claimant. Section 101(31) defines an “insider” as a person with a particular relationship to a debtor. Section 1129(a)(10) also excludes, for purposes of confirmation, “any acceptance of the plan by an insider.” Therefore, the Ninth Circuit reasoned that if Congress intended courts to look to the claim, rather than the individual, in determining insider status, then one would expect to find references to “the holder of an insider claim” in § 1129 rather than references to the insider, itself, without a reference to the claim. Further, it noted that focusing on the claim rather than the person holding the claim could run counter to cases decided in the opposite context (i.e., when an insider purchases a claim from an non-insider). At least two bankruptcy courts have held that insider status persists, regardless of the category of claim. See, e.g., In re Applegate Prop., Ltd. (W.D. Tex. 1991) and In re Holly Knoll P’ship (E.D. Pa. 1994).

Second, the Ninth Circuit rejected U.S. Bank’s contention that the Bankruptcy Court’s ruling would prejudice secured creditors (like U.S. Bank). The Court rattled-off multiple confirmation requirements designed to protect these creditors: (1) the plan and plan proponent must comply with the Bankruptcy Code; (2) the plan must be proposed in good faith; (3) the plan proponent must disclose the identity of all insiders and potential insiders; (4) at least one class of impaired claims must accept the plan (excluding insider votes); (5) the plan must be “fair and equitable” under § 1129(b)(2); and (6) under § 1126(e), the court “may designate any entity whose acceptance or rejection of [a] plan was not in good faith, or was not solicited or procured in good faith.”

The Ninth Circuit also reviewed U.S. Bank’s cross-appeal on the Bankruptcy Court’s holding that Dr. Rabkin was not a non-statutory insider. After stating the standard for a non-statutory insider—(1) the closeness of its relationship with the debtor is comparable to that of the enumerated insider classifications in § § 101(31) and (2) the relevant transaction is negotiated at less than arm’s length—the Ninth Circuit affirmed under a clear error standard.

Conclusion

As debtors’ attorneys, we can’t help but agree with the outcome. (For a creditor attorney’s contrary take, see King & Spalding’s post by Sarah Borders here). A claimant is either an insider or it’s not. The Ninth Circuit correctly rejected the bankruptcy court’s attempt to make new law in providing for transfer of the insider status along with the claim. The Code simply doesn’t provide for “springing insiders.”

If a creditor is neither a statutory insider nor found to be a non-statutory insider, the inquiry reduces to a “bad faith inquiry.”  We don’t see bad faith even if Dr. Rabkin purchased the claim in an attempt to confirm the plan. We don’t view purchasing a claim to assure confirmation of a plan as bad faith, per se. Indeed, creditors purchase claims in an attempt to block confirmation and would vigorously resist any allegation that such an action was bad faith per se.

While we do see this as a potential means by which to cram down a plan on a secured creditor, it’s difficult to imagine many cases where there is a willing purchaser with the ability to dominate or swing a class in favor of the proposed plan. Even if this strategy is followed, as the Ninth Circuit correctly pointed out, the dissenting secured creditor can take comfort in the fact that § 1129 and other provisions of the Bankruptcy Code provide numerous protections to the secured creditor, the most important of which is the requirement that the plan must be “fair and equitable” as to each impaired class of claims or interests. This includes for the secured creditor the right to receive at least the present value of its claim.

Indeed, we can’t help but speculate as to U.S. Bank’s motivations. It appears to us that they were seeking to force the debtor to liquidate or credit bid for the property at liquidation value and reap a profit on the resale. When this motivation to make a buck at the expense of the debtor is compared to that of the debtor in seeking to confirm a plan that would allow it to remain a going concern business, we can’t help but feel that the policies of encouraging reorganization and maintaining value underlying the Bankruptcy Code were upheld.

One person’s successful confirmation of a plan of reorganization is another person’s bad faith abuse of the rules. Last month in In re The Village at Lakeridge, LLC, the Ninth Circuit Court of Appeals waded into just such an area: the intersection of claims buying, insider status, and plan voting. Specifically, it addressed whether a non-insider creditor who purchases a claim from an insider is considered an insider for voting purposes. While it is well-settled that an insider’s vote is not counted for confirmation purposes under § 1129(a)(10), it was an open question, at least in the Ninth Circuit, whether insider status follows the insider claim’s in the hands of a non-insider purchaser. This is an important confirmation issue, especially in close cases where every vote matters.

Continue Reading Insider Status Travels With Claim? 9th Circuit Says No

The use of third-party releases in Chapter 11 has become more permissible in recent years, and, because it is such a potent tool, the exact contours and limits of these releases have been hotly debated. We first blogged about third-party releases last year in our series on the confirmation-related recommendations in the ABI Commission Report. As a part of that post, we covered the Eleventh Circuit’s Seaside opinion regarding third-party releases. As a follow-up, we’ll now review last month’s HWA Properties, Inc. opinion out of the Middle District of Florida. HWA, which applies Seaside, provides a good illustration of the limits of the third-party releases.

Case Background

HWA Properties, Inc., represented by our friends at Stichter, Riedel, Blain & Postler, P.A., filed its Chapter 11 case in the Middle District of Florida. HWA was a corporation owned by real estate developers, Mr. and Ms. Albright, who also owned or controlled numerous other real estate entities. Shortly before filing, HWA owned 13 undeveloped lots and 5 acres of vacant land in Florida and vacant land in Michigan. HWA had transferred several of the lots prior to bankruptcy. Some creditors asserted in the bankruptcy case that the transfer was, under § 548, an avoidable fraudulent transfer.

The Debtor and the Albrights negotiated a global settlement with their creditors. Consenting creditors included BB&T, FineMark National Bank & Trust, Least, LLC, FMIRE, Inc., and BCB Tarpon, LLC. Under the settlement, each of those creditors was to release HWA, the Albrights, and their other entities in exchange for cash or for the land owned by HWA prior to the transfers.

The global settlement required, as a condition precedent to its enforceability, that the bankruptcy court enter a bar order barring all claims against BCB Tarpon (the recipient of all shares of HWA under the plan), the Albrights, and their entities “that relate in any way to the Debtor.” The settlement did not include the Davis Group, which held the senior mortgage on four of the lots that the debtor transferred before filing. Under its plan, HWA proposed to restructure the mortgage by lowering the interest rate from 12% to 6% and extending the maturity rate from July 2016 to fifteen years after confirmation. The global settlement also did not include Community & Southern Bank. Although not one of HWA’s creditors, C&S held a $1,912,000 judgment against Mr. Albright.

The United States Trustee, the Davis Group, and C&S objected to the bar order. They contended that the proposed release and bar order (as well as the Plan, which incorporated those provisions) could not be confirmed. The bankruptcy court agreed and denied confirmation of the plan and approval of the compromise.

The Opinion

Judge Delano first looked to the Eleventh Circuit’s release of non-debtors in In re Munford. In Munford, the debtor sued several defendants for breach of fiduciary duties. When one defendant offered to settle, the offer was conditioned on the bankruptcy court issuing a bar order preventing the other defendants from pursuing contribution or indemnity claims against it. The Eleventh Circuit cited three justifications for entering a bar order: (i) public policy strongly favors pretrial settlement due to the potential of a complex case to drain resources; (ii) litigation costs are particularly burdensome on the bankruptcy estate given the financial instability of the estate; and (iii) bar orders play an integral role in facilitating settlement.

Judge Delano then reviewed In re Dow Corning Corp., the seminal Sixth Circuit case that first listed seven factors for courts to consider when faced with a request to enjoin a non-consenting creditor’s claim against a non-debtor. We covered Dow Corning in a prior post.

Judge Delano concluded her survey by reviewing the Eleventh Circuit’s Seaside opinion from March 2015. She noted that Seaside focused on the ability of the bar order “to prevent claims against non-debtors that would undermine the operations of, and doom the possibility of success for, the [reorganized] debtor.” She also focused on the requirement that the bar order be fair and equitable under the facts and circumstances and be used cautiously and infrequently.

Ultimately, Judge Delano considered each of the seven Dow Corning factors. She found that two of the factors were inapplicable and that five of the factors suggested that entering the bar order would be inappropriate. Most importantly, though, she focused on two intertwining issues: (1) the liquidating nature of the proposed plan and (2) the lack of a relationship between the two objecting creditors and the debtor.

Judge Delano concluded that “the fundamental problem in this case is that the Plan does not propose a true reorganization; instead the Plan is a restructuring of various obligations in an effort to obtain releases for Mr. and Mrs. Albright and their entities.” Indeed, it appeared that the Albrights were attempting to use the bankruptcy court’s jurisdiction over a single one of their entities to resolve disputes between all creditors of themselves, the debtor, and various Albright entities.

Judge Delano viewed with special distaste the Albrights’ attempt to resolve the judgment against Mr. Albright in favor of C&S in the context of HWA’s case. “If Mr. Albright wants a discharge of his obligation to C&S, he should file his own bankruptcy. It is not fair and equitable for a judgment debtor to obtain what is, in effect, a Chapter 7 discharge when that party has not made full disclosure of his assets and liabilities and submitted to the administration of a Chapter 7 trustee.”

Therefore, the attempted third-party releases failed.

Conclusion

We can draw two lessons from HWA.

First, HWA highlights the need for a strong nexus between the requested bar order and the debtor to overcome the elimination of a creditor’s rights. The nexus can be in the form of a creditor’s refusal to settle a cause of action held by the debtor without the proposed bar order (as was the case in Munford). It can also be the potential to inhibit the post-confirmation operation of the debtor (as was the case in Seaside). When the debtor is liquidating, though, as in HWA, the concern for a strong nexus is even stronger because, all things being equal, there is no reason to protect a liquidating debtor post-confirmation.

Second, HWA also highlights the issues that arise when debtors seek to include within the bar order debts over which the bankruptcy court lacks jurisdiction. Judge Delano highlighted one of these concerns: obtaining what is, in effect, a discharge as to the barred creditors without accompanying full disclosure. We would add that this also raises due process concerns as to the creditor who is not before the bankruptcy court.

There very well may be an appropriate case for a non-debtor including in a proposed release a creditor who is not a creditor of the debtor. However, the debtor’s attorney must be careful to illustrate the strong nexus between this debt and the debtor and the necessity of the bar order to the debtor.

If you’d like to stay on top of third-party releases and other important confirmation issues, then you can subscribe to Plan Proponent via email here.

Justice Antonin Scalia died on Saturday. He was 79. Politics aside, he was a legal giant on the world’s most powerful court. However, we’ll leave the tributes to those who knew Justice Scalia and those who make their careers studying the Supreme Court. Instead, we chose a more modest (but still demanding) purpose for this post: To catalog the bankruptcy opinions that Justice Scalia wrote for the majority and 2 of his most significant bankruptcy dissents. Fortunately or unfortunately, there is no “jiggery-pokery,” “pure applesauce,” “argle-bargle,” or the like to be found in these opinions. Rather, Justice Scalia, as bankruptcy justice, is, if we accept Yury Kapgan’s dichotomy, more “humble rhetorician” than “scolding pedagogue.” Enjoy.

Introduction

Even a cursory review of the headlines will likely lead one to predict that Justice Scalia’s unexpected death could result in a seismic change in ideology on the Supreme Court. We’re told that everything’s now, or soon could be, in crisis, be it the GOP, the 2016 Election, the Supreme Court, the Constitution, the Government, the Nation, etc. After all, the Supreme Court was (and still is) set to consider a slew of important cases during the remainder of this term, including abortion, immigration, birth control, affirmative action, congressional redistricting, and even, as one viral article put it, the “Fate of the Earth” itself (climate change).

Of course, the source of the pandemonium is easy to trace: For nearly 30 years, Justice Scalia served as a conservative bulwark on an often-divided Court. Many assume that Justice Scalia was a conservative justice and, therefore, always voted up and down the party line. That very well might be the case on national, hot-button issues. But what about the more esoteric, statutory areas? In Theory and Practice of Statutory Interpretation, Prof. Frank Cross submits that “research has shown a very significant association between ideology and judicial votes.” However, he also points out that the “ideological” or “attitudinal” model does not “predict outcomes in numerous statutory areas” (including antitrust, ERISA, and bankruptcy).

Justice Scalia’s bankruptcy opinions, although providing a relatively small sample size, bear that point. From the 10 majority opinions inventoried below, 6 were unanimous and, of the 4 that involved dissents, 3 had 2 or fewer justices dissenting. To be sure, these are not the polemic, 5-4 decisions that Justice Scalia is so famous for. And when there is a dissent, it’s often a disagreement about statutory construction. Even Justice Scalia’s dissents were less about bankruptcy and more about interpretive approaches. Indeed, as one panel put it, bankruptcy cases “often serve as a crucible for competing theories of statutory interpretation.”

That same panel cites Prof. Robert Rasmussen’s article. In 1993, Prof. Rasmussen submitted that the “Supreme Court’s bankruptcy cases evince a definite trend toward textualist interpretation.” It’s fitting, then, that he points to Justice Scalia as “the justice most credited with the Court’s increasing reliance on statutory text.”He explains that “textualism” is based on the “notion that the text of a statute is the exclusive authority on which the Court should rely when reaching its decision. When a statute is ambiguous, the Court should ascribe to the statute that meaning which most persons would ascribe to the language at issue. Legislative history is not consulted, nor is a judge’s sense of which interpretation implements the better social policy.”

Therefore, we submit that there is no better way to understand the Supreme Court’s statutory approach in bankruptcy cases than reading Justice Scalia’s bankruptcy opinions. They provide an original treatise of sorts on textualism and the tension between it and other approaches. And in the process, the bankruptcy opinions, themselves, provide a tribute to their formidable author.

Justice Scalia’s Majority Opinions in Bankruptcy Cases

By our count, Justice Scalia wrote the majority opinion in 13 bankruptcy cases. We’ll cover the Top 10 most cited, from least to most cited.

10. RadLAX Gateway Hotel, LLC v. Amalgamated Bank (2012)

Justice Scalia wrote this unanimous confirmation-related decision for the Court.

RadLAX had purchased the Radisson Hotel at LAX. RadLAX borrowed $142 million from an investment fund for development. Amalgamated Bank was the fund’s trustee (and, arguably, has the worst bank name in the history of bank names). RadLAX and its affiliate filed Chapter 11 cases. They proposed to sell substantially all of their assets via a “stalking horse” sale with an initial $47.5 million stalking horse bid. However, the bidding procedures prohibited “credit bidding” by the bank. Rather, they required the bank to bid cash at the sale.

The Bankruptcy Court, the Seventh Circuit (on direct appeal), and then the Supreme Court rejected the proposed bidding procedures because they eliminated credit bidding. Justice Scalia rejected RaxLAX’s “hyperliteral” and nonsensical attempt to avoid one cramdown provision in favor of another. For Justice Scalia, it was just a matter of taking § 1129(b)(2)(A) for a test drive. He starts with the structure of the statute. That is, a plan can be “fair and equitable” as to a secured creditor and, thus, “crammed down” over its objection in 1 of 3 ways under § 1129(b)(2)(A).

First, secured creditors can retain all liens securing their claims and receive, as of the plan effective date, the full value of their claim (with interest as necessary).

Second, a debtor can sell the secured creditor’s collateral free and clear, subject to the creditor’s credit bid rights under § 363(k).

Third, the secured creditor can realize the “indubitable equivalent” of its claims.

RadLAX tried to fly in under the third alternative because its cash-only bidding requirement violated the second alternative. However, its attempt couldn’t withstand Justice Scalia’s lesson on statutory construction. Specifically, Justice Scalia emphasized (i) Congress’ “comprehensive scheme” and (ii) how the “specific governs the general.” “The general/specific canon explains that the ‘general language’ of clause (iii), ‘although broad enough to include it, will not be held to apply to a matter specifically dealt with’ in clause (ii).” And because the debtor couldn’t point to anything in the Code to overcome that explanation, the debtor lost.

Justice Scalia concludes that the “Bankruptcy Code standardizes an expansive (and sometimes unruly) [haha] area of law, and it is our obligation to interpret the Code clearly and predictably using well established principles of statutory construction…Under that approach, this is an easy case.”

9. F.C.C. v. NextWave Personal Communications, Inc. (2003)

In the NextWave case, the Court, led by Scalia, held that § 525 of the Bankruptcy Code prohibited the FCC from revoking NextWave’s “spectrum licenses” after NextWave failed to make timely payments to the FCC on its $4.74 billion license purchase.

Section 525 prohibits certain “discriminatory treatment” by governmental units with respect to licenses, permits, and the like. In short, the Court concluded that NextWave’s obligations to the FCC under the purchase agreement were “debts” under the Code, the FCC’s “regulatory motive” in cancelling the licenses was irrelevant, and no exceptions applied to the FCC’s actions.

In typical Scalia fashion, Justice Scalia concluded that the FCC’s attempt to avoid § 525 “flies in the face of the fact that, where Congress has intended to provide regulatory exceptions to provisions of the Bankruptcy Code, it has done so clearly and expressly, rather than by a device so subtle as denominating a motive a cause.” He also scolded Justice Breyer, who dissented, for attempting to divine the “purpose” of § 525 “in splendid isolation” from its language.

8. Young v. U.S. (2002)

In Young, Justice Scalia wrote another unanimous opinion. It’s less a “Scalia opinion” than it is the Justices joining together to close a potentially abusive loophole in the Bankruptcy Code. For that reason, the facts are more interesting than the decision.

A couple filed a Chapter 13, moved to dismiss it before confirmation, filed a Chapter 7 one day before a ruling on the dismissal, and then obtained their Chapter 7 discharge. Later, the IRS attempted to collect a tax debt from the debtors. They moved to reopen their Chapter 7 case for a declaration that the tax debt had been discharged under § 523(a)(1)(A) because it pertained to a tax return due more than three years before their Chapter 7 filing.

A unanimous Court held that § 507(a)(8)(A)(i)’s lookback period is tolled during the pendency of a prior bankruptcy petition in accordance with “traditional equitable tolling principles” applicable to limitation periods. In other words, “Nice try debtors!” Tolling protected the IRS, regardless of whether the debtors filed their Chapter 13 in good faith or “solely to run down the lookback period.” We can almost hear Justice Scalia yawning at his keyboard.

7. Owen v. Owen (1991)

Owen addresses an issue that gives my colleagues and me fits: lien avoidance. And admittedly, Justice Scalia’s opinion (with Justice Stevens dissenting) is not an easy read. In fact, if it weren’t smack dab in the middle of our Top 10 list, we might leave it off. In all seriousness, Owen involved a debtor whose former spouse had obtained a $160,000 judgment against the debtor. The judgment eventually had some Florida property to attach to when the debtor later acquired a condo. The debtor filed a Chapter 7. The debtor claimed that the condo was exempt and also moved to avoid his spouse’s judgment lien pursuant to § 522(f).

Justice Scalia held that the appropriate question under § 522(f) is whether the condo would be exempt if the debtor’s spouse didn’t have lien, not whether the debtor had a right to, in light of the lien, to exempt the condo. In his words, “to determine the application of § 522(f) [courts] ask not whether the lien impairs an exemption to which the debtor is in fact entitled, but whether it impairs an exemption to which he would have been entitled but for the lien itself. As the preceding italicized words suggest, this reading is more consonant with the text of § 522(f)-which establishes as the baseline, against which impairment is to be measured, not an exemption to which the debtor ‘is entitled,’ but one to which he ‘would have been entitled.'” [Insert Scalia’s maniacal laughter.]

6. Citizens Bank of Maryland v. Strumpf (1995)

Citizens Bank is another unanimous opinion written by Justice Scalia. Strumpf, a Chapter 13 debtor, was in default under his loan with Citizens when he filed. He also had a checking account with Citizens. In response to the filing, Citizens placed an administrative hold on the bank account consistent with its right of setoff. It also filed a motion for stay relief and setoff. Therefore, it refused to honor withdrawals from the account while the motion was pending.

As a reminder, the right of setoff allows entities that owe each other money to apply their mutual debts against each other. In the Citizens context, the money in the bank account is, in essence, a debt owed to the debtor by the bank. Of course, § 362 stays a creditor’s exercise of its setoff rights. The issue in Citizens was whether Citizens violated the automatic stay when, to protect its setoff right, it temporarily declined to honor the bank account withdrawal requests.

Reversing the Fourth Circuit, Justice Scalia held that Citizens’ actions did not constitute a “setoff” under § 362(a)(7) and, thus, did not violate the automatic stay. He emphasized that Citizens’ refusal to pay was not permanent or absolute. Rather, it was only temporary while Citizens pursued stay relief. Whether viewed under state law or under § 542(b) and § 553(a), an action in setoff requires an intent to permanently settle an account.

5. U.S. Bancorp Mortg. v. Bonner Mall Partnership (1994)

Bonner Mall is not so much a bankruptcy case as it is a procedure case that arose in a bankruptcy case. It’s worth including, though, if only because we’ve encountered nearly the exact facts in two of our recent Chapter 11 cases, each of which involved confirmation settlements that mooted pending appeals.

Bonner filed a Chapter 11. U.S. Bancorp was its secured lender. Bonner’s plan relied on the “new value” exception to the absolute priority rule. U.S. Bancorp filed a confirmation objection, claiming that the plan was unconfirmable on its face. The Bankruptcy Court agreed and Bonner appealed. The District Court overruled and U.S. Bancorp appealed. The Ninth Circuit affirmed. After the Supreme Court granted cert and received merits briefs, the parties settled. Their settlement resulted in the confirmation of a consensual plan. Nevertheless, U.S. Bancorp moved the Supreme Court to vacate the Ninth Circuit under 28 U.S.C. § 2106.

Writing once again for a unanimous Court, Justice Scalia denied the motion. On the one hand, he explained that the Court had the power to hear the motion to vacate. Whereas Article III prevented the Court from considering the merits of a judgment that becomes moot pending review, the Court still had the power to dispose of the whole case as justice may require. On the other hand, he explained that mootness via settlement doesn’t justify vacating a judgment. Pointing out that the “vacatur power” relies on equitable principles, Justice Scalia pointed to the principal equitable factor: Whether the party seeking vacatur is the party who caused the mootness. In short, U.S. Bankcorp forfeited the vacatur remedy when it settled.

4. BFP v. Resolution Trust Corp. (1994)

BFP was a 5-4 decision, with Justice Scalia writing for the majority, wherein the Court considered the meaning of “reasonably equivalent value” in § 548(a)(2). BFP, a Chapter 11 debtor, had its California beachfront property foreclosed on by Imperial Federal, pre-petition. In the bankruptcy case, BFP sued to avoid the pre-petition foreclosure as a fraudulent conveyance, arguing that the home was worth $725,000, not $433,00 (the amount paid at foreclosure).

On behalf of the majority, Justice Scalia concluded that a “reasonably equivalent value” for foreclosed property is the price brought at foreclosure as long as the foreclosing party complied with all of the applicable state law foreclosure requirements. In other words, “reasonably equivalent value” and “fair market value” are not necessarily synonymous under the Code.

Consistent with many of Justice Scalia’s opinions, his BFP opinion is intricate and thorough, replete with a history of fraudulent conveyance law back to the “Statute of 13 Elizabeth” and a history of foreclosure law, also back to England. And of course, Justice Scalia left no stone unturned in responding to the dissent, stating that “one searches Justice Souter’s opinion in vain for any alternative response to the question of [a] transferred property’s worth.”

Indeed, Justice Scalia was not satisfied, as he continues: “The dissent has no response, evidently thinking that, in order to establish that the law is clear, it suffices to show that ‘the eminent sense of the natural reading’ provides an unanswered question. Instead of answering the question, the dissent gives us hope that someone else will answer it, exhorting us ‘to believe that [bankruptcy courts], familiar with these cases (and with local conditions) as we are not, will give [‘reasonably equivalent value’] sensible content in evaluating particular transfers on foreclosure. While we share the dissent’s confidence in the capabilities of the United States Bankruptcy Courts, it is the proper function of this Court to give ‘sensible content’ to the provisions of the United States Code.”

[We always enjoy when the Supreme Court gives the Bankruptcy Courts a thumbs-up–sometimes it’s sincere; other times, we wonder.]

3. Hartford Underwriters Ins. Co. v. Union Planters, N.A. (2000)

Hartford is another unanimous Justice Scalia bankruptcy opinion.

Hen House Interstate, Inc. filed a Chapter 11. During the case, it obtained workers comp insurance from Hartford Underwriters. Although the debtor repeatedly failed to pay premiums, Hartford kept the insurance in place. Eventually, Hen House had its case converted to a Chapter 7. Hartford realized that the debtor has no unencumbered funds. Therefore, as an administrative claimant under § 503(b), it sought to surcharge Union Planters’ collateral for the unpaid premiums under § 506(c). Union Planters was Hen House’s secured lender. Hartford was successful until the Eighth Circuit, sitting en banc, shut it down.

Writing for a unanimous Supreme Court, Justice Scalia viewed the issue very simply: § 506(c) permits the “trustee” (and only the trustee) to recover from a secured party’s collateral. Hartford was not the trustee. Therefore, it could not surcharge the collateral. Period.

2. U.S. v. Nordic Village, Inc. (1992)

In Nordic Village, a 7-2 Supreme Court, with Justice Scalia writing for the majority, held that § 106(c) doesn’t establish “an unequivocal waiver” of government immunity from a bankruptcy trustee’s claims for monetary relief. Justice Stevens and Justice Blackmun dissented.

Nordic Village was a Chapter 11 debtor. Mr. Lah, one of its officers, withdrew $24,000 from the debtor’s bank account and paid $20,000 of it to the IRS for application against his individual liability. The Chapter 11 trustee sued to avoid the transfer. Ultimately, the Bankruptcy Court ruled that the transfer could be avoided under § 549(a) and recovered from the IRS under § 550(a). The District Court affirmed the money judgment against the IRS, as did a divided Sixth Circuit.

Justice Scalia reasoned that, whereas § 106(a) and § 106(b) constituted unequivocal waivers of sovereign immunity, 106(c) was subject to at least two competing interpretations, such that any waiver of immunity in § 106(c) was not unequivocal. The dissent accused Justice Scalia of “stubborn insistence” on “clear statements,” an insistence that the dissent believed “burdens the Congress with unnecessary reenactment of provisions that were already plain enough when read literally.” Uncharacteristically, Justice Scalia didn’t take the bait, and left the dissent alone.

1. United Sav. Ass’n of Texas v. Timbers of Inwood Forest Assocs., Ltd. (1988)

If there is one case that you’ve already read, then it’s likely Timbers. And if you haven’t read it, then you definitively should read it, right this second, in fact. Indeed, Timbers is so important and so much has already been written about it that we’ll simply do 2 things here.

First, remind you that Justice Scalia wrote the unanimous Timbers decision. Second, restate its holding: An undersecured creditor isn’t entitled to compensation (e.g., interest) under § 362(d)(1) for the delay caused by the automatic stay in foreclosing on their collateral.

There. Now go read or re-read Timbers.

(Bonus: The Supreme Court even quoted Timbers in last summer’s King v. Burwell (a/k/a Obamacare) decision: “A provision that may seem ambiguous in isolation is often clarified by the remainder of the statutory scheme…because only one of the permissible meanings produces a substantive effect that is compatible with the rest of the law.” Don’t get us started on the “Whole Act” rule of construction!)

Justice Scalia’s Dissenting Opinions in Bankruptcy Cases

By our count, Justice Scalia wrote a dissenting opinion in 4 bankruptcy cases. We’ll cover 2 of the big ones.

1. Dewsnup v. Timm (1992)

In Dewsnup, the majority held that § 506(d) does not permit a debtor to “strip down” a creditor’s lien to the judicially-determined value of the collateral. The majority reasoned that, because the subject creditor’s claim was secured by a lien and had been fully allowed pursuant to § 502, the claim could not be classified as “not an allowed secured claim” for purposes of § 506(d)’s lien-voiding provision. Yes, Justice Scalia can get away with double negatives! Dewsnup is an important case in the canon of Supreme Court bankruptcy opinions. In fact, it played a prominent role in last summer’s junior lien-stripping case, Bank of Am., N.A. v. Caulkett, wherein the Court held that a Chapter 7 debtor could not “lien strip” junior liens that are wholly underwater.

Justice Scalia concludes that § 506(d) automatically voids a lien to the extent that the claim it secures is not both an “allowed claim” and a “secured claim.” However, his disagreement with the majority’s outcome is less interesting than his disagreement with its interpretive approach, especially in the context of this blog post where Justice Scalia’s judicial philosophy is more relevant than any discrete outcome, much less a bankruptcy outcome.

Indeed, it appears that Justice Scalia could care less about the bankruptcy policy in his Dewsnup dissent. More than any other decision addressed in this post, his Dewsnup dissent arguably sums up best his interpretive philosophy while communicating the tenacity that made him an important force to be reckoned with on the Court for nearly 30 years:

The principal harm caused by today’s decision is not the misinterpretation of § 506(d) of the Bankruptcy Code. The disposition that misinterpretation produces brings the Code closer to prior practice and is, as the Court irrelevantly observes, probably fairer from the standpoint of natural justice…The greater and more enduring damage of today’s opinion consists in its destruction of predictability, in the Bankruptcy Code and elsewhere. By disregarding well-established and oft-repeated principles of statutory construction, it renders those principles less secure and the certainty they are designed to achieve less attainable. When a seemingly clear provision can be pronounced “ambiguous” sans textual and structural analysis, and when the assumption of uniform meaning is replaced by “one-subsection-at-a-time” interpretation, innumerable statutory texts become worth litigating…Having taken this case to resolve uncertainty regarding one provision, we end by spawning confusion regarding scores of others. I respectfully dissent.

2. Till v. SCS Credit Corp. (2004)

Much has been written about Till. There’s even a Till song! It’s also one of our favorite cases to blog about. We’ve covered Till here and here. Therefore, we won’t dwell on it. Suffice it to say, Justice Scalia’s dissent in Till is arguably his most famous bankruptcy opinion. And if you haven’t read Justice Scalia’s dissent in Till, then you haven’t really read Till.

In short, Justice Scalia rejected the Till plurality’s “prime plus” approach. He writes: “Our only disagreement is over what procedure will more often produce accurate estimates of the appropriate interest rate. The plurality would use the prime lending rate-a rate we know is too low-and require the judge in every case to determine an amount by which to increase it. I believe that, in practice, this approach will systematically undercompensate secured creditors for the true risks of default.” Instead, Justice Scalia opted for the “presumptive” “contract rate.”

Did he choose the wrong approach? Yep (says these debtor lawyers). Did he care at all what we think? Nope.

Conclusion

Whether he was writing for the majority, concurring to isolate a particular point, or dissenting to keep the Court honest, Justice Scalia arguably steered a relatively young Bankruptcy Code in the courts more than any other judge or justice during his nearly 30 year term. Nevertheless, his bankruptcy opinions speak for themselves. Therefore, as I hit the 3724 (!) word mark in this post, I’ll simply close with my favorite, and doubly-fitting, Scalia quote. When a young student asked Justice Scalia what he enjoyed most about being a Supreme Court justice, Justice Scalia remarked that he doesn’t enjoy writing. Rather, he enjoys “having written.” Anyone who has ever drafted a brief or an overly long blog post can surely relate! And today, Justice Scalia “having written” takes on a special meaning.

If you’d rather hear it for yourself, then click here for a short clip: http://www.c-span.org/video/?c4580989/written

Baker Botts

On Monday in the Samson Resources Corporation Chapter 11 bankruptcy case, Delaware’s Judge Sontchi adopted Judge Walrath’s recentBaker Botts opinion in Delaware’s Boomerang Tube Chapter 11 case regarding fee-defense costs after Baker Botts. As we discussed last week, Judge Walrath’s opinion interpreted the U.S. Supreme Court’s Baker Botts, L.L.P. v. ASARCO opinion, a case that we’ve been covering since last June. Specifically, she held that neither § 328(a) of the Bankruptcy Code, nor a retention agreement provides a sufficient Baker Botts workaround. As a recap, the Supreme Court held in Baker Botts that professionals employed under § 327(a) may not be reimbursed for fees that they incur in defending their bankruptcy fee applications.

Judge Sontchi’s Letter to Counsel

Judge Sontchi voiced his agreement with Judge Walrath in a letter to counsel.

He starts out by acknowledging that, whereas Boomerang involved an application to employ counsel for the unsecured creditors committee, the Samson issue involved applications to employ counsel for the debtor, including one by Kirkland & Ellis. However, like the application in Boomerang, the Samson applications proposed, by virtue of their respective engagement letters, that the debtor reimburse counsel for their fee-defense costs.

Therefore, Judge Sontchi “agree[d] with and endorse[d] the reasoning of  Judge Walrath in Boomerang Tube.” He emphasized Judge Walrath’s ruling that she would have reached “the same conclusion if the fee defense provisions were in a retention agreement filed by any professional under section 328(a)–including one retained by the debtor. Such provisions are not statutory or contractual exceptions to the American Rule and are not reasonable terms of employment of professionals.” For Judge Sontchi, Judge Walrath’s “reasoning in Boomerang Tube is equally applicable” to the Samson applications.

And with that, Judge Sontchi directed the parties “to submit a proposed order under certification of counsel incorporating this ruling.”

[We aren’t Delaware bankruptcy lawyers, so this might be a dumb question, but how does that work? Would the debtor recite in the certification that it doesn’t consent to the order so that it preserves its right to appeal the order? To be sure, as in Boomerang, Baha Mar, and New Gulf Resources, Andrew Vera, the U.S. Trustee in Delaware, was the party who objected to the reimbursement provisions.]

Conclusion

We aren’t surprised that Judge Sontchi adopted Judge Walrath’s opinion. As Bracewell’s Evan Flaschen put it last week in response to the Boomerang opinion, “[m]y reading . . . is that this is the rule in Delaware.” Therefore, like us, he didn’t see other bankruptcy courts “diving in to have a different result.” That’s all for now. We’ll continue to keep you posted on Baker Botts as it develops in the lower courts.

If you’d like to stay on top of this issue and other important bankruptcy issues, then you can subscribe to Plan Proponent via email here.

[Speaking of Evan, whose firm represented ASARCO in the Supreme Court, Reuters’ Jim Christie quoted Evan and me in his article on the Boomerang opinion. I also did a short Baker Botts Q&A with Jim back in December. Click here and here.]

 

 

(I’m told that these are “Boomerang Tubes”)

Back in September, we blogged about two pending Delaware bankruptcy cases regarding fee-defense costs after Baker Botts, L.L.P. v. ASARCO: In re Boomerang Tube, LLC, et al. and In re Northshore Mainland Services, Inc., et al. (a/k/a the Baha Mar case). In Baker Botts, the Supreme Court held that professionals employed under § 327(a) of the Bankruptcy Code may not, under § 330(a), recover as compensation fees incurred in defending their bankruptcy fee applications. Here’s a link to our combined Q&A post.

This post will serve as an update, as Delaware’s Judge Walrath entered an opinion on Friday sustaining the United States Trustee’s objection in the Boomerang case. In short, she held that neither § 328(a) nor a retention agreement provides a sufficient Baker Botts workaround. Her reasoning, which we’ll summarize, tracks with our analysis from July and September.

First, § 328(a), like § 330(a), doesn’t provide a statutory exception to the “American Rule” on attorneys’ fees. Second, even if the engagement letter is a contract, it remains subject to bankruptcy court approval. Therefore, it doesn’t provide a contractual exception to the American Rule on attorneys’ fees. Ultimately, § 330(a), as limited by Baker Botts, determines the reasonableness of a fee provision.

Background

As a reminder, the Boomerang Tube Committee proposed in its attorney employment application that, as “part of the compensation payable to Brown Rudnick, the Committee agrees that Brown Rudnick shall be indemnified and be entitled to payment from the Debtors’ estates, subject to approval by the Court pursuant to 11 U.S.C. §§ 330 and 331, for any fees, costs or expenses, arising out of the successful defense of any fee application by Brown Rudnick in these bankruptcy cases in response to any objection to its fees or expenses in these Chapter 11 cases.” It also cited § 328(a) in support of the proposed indemnification.

Andrew Vara, the Acting United States Trustee in Delaware, objected here. He made five objections. We summarized them here, but here they are again:

  1. Like § 330(a), § 328(a) doesn’t overcome the American Rule.
  2. After Baker Botts, fee-defense is not a compensable “service.”
  3. Indemnification is not a “reasonable” term under § 328(a).
  4. Indemnification fails under § 330(a), the exclusive compensation provision.
  5. Professionals can’t overcome Baker Botts via mere consent.

The Boomerang Decision

Judge Walrath’s opinion is a good, easy read, but here are the high points:

First, the Court acknowledges that § 328(a) is an exception to § 330(a). However, like § 330(a), § 328(a) doesn’t explicitly authorize an award of fees to a prevailing party in adversarial litigation. Therefore, without more, the American Rule (i.e., each party pays its own fees) still applies. In contrast, the Court then catalogs at least 6 other Bankruptcy Code provisions that do contain American Rule exceptions. See p. 6 of the opinion.

Second, the Court makes an important distinction: Baker Botts doesn’t hold that § 330 prohibits fee-defense compensation. Rather, it simply doesn’t provide a statutory basis for it. Therefore, Baker Botts doesn’t preclude the possibility of a contractual exception to the American Rule. And thus the issue: Do retention agreements provide an American Rule exception (and Baker Botts workaround)? The Court answers “No.”

Specifically, the Court agrees that retention agreements are contracts. However, they still must provide “contractual exceptions” to the American Rule. The Court holds that the subject agreement provides no such exception. Rather than viewing the agreement as an agreement between 2 parties that the losing party pays the winning party’s fees, the Court views it as an agreement between the Committee and its proposed counsel that if counsel prevails on a fee objection, then a third party (the bankruptcy estate) will pay the fee defense costs. That contract, concludes the Court, can’t bind the estate (i.e., a non-party).

Third, and we think more convincing, the Court views the retention agreement as a contract that’s subject to Court modification and approval under the Bankruptcy Code.  As the Court views it, the proposed fee defense provisions are not “reasonable” terms under § 328(a) because they propose compensation for fee-defense which, after Baker Botts, is not a “disinterested” “service” for which compensation can be owing. It doesn’t matter what one party may have agreed to if that agreement conflicts with the Code.

As a reminder, § 328(a) emphasizes “reasonable terms and conditions of employment.” Further, explains the Court, even if courts have permitted similar indemnification provisions, they did so before Baker Botts and, even then, those cases usually involved financial advisors for whom indemnification is common outside of bankruptcy. Further still, the Court concludes that, after (dicta in) Baker Botts, § 330(a), not market factors, is the appropriate focus for assessing reasonableness under § 328(a).

Finally, the Court concludes that the outcome doesn’t change if one views the fee-defense exercise as an “expense” rather than as a “fee.” According to the Court, both are subject to the American Rule and to Baker Botts. It also predicts that the Supreme Court would have stuck with its ruling even if there had been a § 328(a) agreement already in place in Baker Botts.

Therefore, the Court rejects the Committee’s 328-based fee-defense provision. It didn’t contemplate a compensable service and, thus, it failed.

Conclusion

As with the Ninth Circuit’s “absolute priority rule” decision from last week, we’ll have more to say about the Boomerang opinion. For example, I suspect that my colleagues will take issue with some of Judge Walrath’s comments regarding whether the estate is or can be a party to a retention agreement. Additionally, I wonder whether the outcome might differ in cases involving agreements between debtor’s counsel and the debtor itself. We also repeat from our September post: Could the Committee’s proposed professionals get an indemnity agreement from the Committee members themselves?

For the moment, our opinion hasn’t changed: Baker Botts is a bad decision because the American Rule makes no sense in the bankruptcy context. Put another way, the Code itself provides the statutory exception to the American Rule. However, as long as § 330 remains tethered to the American Rule, it’s likely a losing battle for professionals seeking fee-defense compensation, no matter how creative they get. For the immediate § 328 issue, we can’t see how the Supreme Court would have read § 327 and § 330 together to exclude defense costs from compensation, but then read § 328 and § 330 together to include defense costs in compensation. Section 330 and, thus, Baker Botts, sits on top of § 328.

In short, we read Baker Botts as the Supreme Court’s (erroneous) determination that the payment of defense costs out of the bankruptcy estate is never reasonable. Hopefully, the Committee’s counsel will appeal–presumably on its own nickel, given Baker Botts.

We’ll keep you posted. If you’d like to stay on top of this issue and other important confirmation issues, then you can subscribe to Plan Proponent via email here.

(If as many people who showed up to the 9th Circuit for Prop 8 showed up for the absolute priority rule, then the absolute priority rule might finally get the attention that it deserves from the U.S. Supreme Court!)

Yesterday, in Zachary v. California Bank & Trust,  the Ninth Circuit overturned the Ninth Circuit Bankruptcy Appellate Panel’s (BAP’s) prior holding on the absolute priority rule in In re Friedman, 466 B.R. 471 (B.A.P. 9th Cir. 2012). Agreeing with the Fourth, Fifth, Sixth, and Tenth Circuits, the Ninth Circuit held that the absolute priority rule continues to apply in individual Chapter 11 reorganizations, even after the 2005 BAPCPA amendments to the Bankruptcy Code. Our goal with this post is to brief the opinion while it’s still “big news.” We’ll follow-up later with some commentary and an update of our “APR Case Chart.”

Factual Background

In Zachary, David Zachary and Annmarie Snorksy filed a voluntary joint individual Chapter 11 petition. Under their proposed plan, their largest unsecured creditor, California Bank & Trust (CBT), was placed in its own class. The debtors proposed to pay CBT $5,000 on its claim of approximately $2,000,000. CBT objected, arguing that the absolute priority rule prevented confirmation of the debtors’ plan. Notwithstanding Friedman (a 2012 “broad view” BAP case), the bankruptcy court sustained the objection. The debtors then sought and obtained a direct appeal to the Ninth Circuit.

The Absolute Priority Rule after BAPCPA

The Ninth Circuit begins by reviewing the two options available to all debtors, including individuals, to confirm a plan under Chapter 11. A debtor may confirm a plan by complying with each of the sixteen subparagraphs in 11 U.S.C. § 1129(a), including obtaining the consent of each class of creditors under § 1129(a)(8). Failing that, the debtor must obtain confirmation of the plan by “cramming down” the plan on dissenting creditors under 11 U.S.C. § 1129(b). A bankruptcy court may only confirm the plan under, among other requirements, the “cramdown provisions of § 1129(b) if the debtor complies with the “absolute priority rule” codified at § 1129(b)(2)(C)(ii).

As we’ve discussed previously, the absolute priority rule is a judicially-created doctrine that was codified in 1978. In essence, the rule “provides that a dissenting class of unsecured creditors must be provided for in full before any junior class can receive or retain any property under a reorganization plan.” Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 202 (1988). The purpose of the absolute priority rule is to prevent deals between senior creditors and equity holders that would impose unfair terms on unsecured creditors. Thus, the absolute priority rule serves to enforce the priority of distributions mandated by the Bankruptcy Code.

However, Congress amended the Bankruptcy Code in 2005 with the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). BAPCPA made two changes relevant to the absolute priority rule.

First, Congress added § 1115. It provides that, in individual cases, “property of the estate includes, in addition to the property specified in section 541“:

(1) all property of the kind specified in section 541 that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first; and

(2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first.

Second, Congress amended the absolute priority rule itself. The pre-BAPCPA and post-BAPCPA versions of the APR are as follows:

Pre-BAPCPA

[T]he condition that a plan be fair and equitable with respect to a class includes the following requirements:

(B) With respect to a class of unsecured claims—

(i)             The plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or

(ii)           The holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account such junior claim or interest any property.

Post-BAPCPA

[T]he condition that a plan be fair and equitable with respect to a class includes the following requirements:

(B) With respect to a class of unsecured claims—

(i)             The plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or

(ii)           The holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account such junior claim or interest any property, except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115, subject to the requirements of subsection (a)(14) of this section.

Narrow versus Broad View

At the risk of being overly simplistic, the split among the courts about these changes is whether an individual debtor can confirm a plan under the cramdown provisions of § 1129(b)(2)(B)(ii) while retaining (A) any portion (or all) of property of the estate that other sections of the Code will allow or (B) only the property and earnings acquired after the commencement of the case that are only property of the estate due to § 1115. In turn, there are two views: the “broad” view and the “narrow” view.

The broad view reads the word “includes” [in the newly-added § 1115(a)] and the word “included” [in the phrase, “property of the estate included under section 1115” in the amended § 1129(b)(2)(B)(ii)] together. Reading “included” broadly, the broad view concludes that a debtor’s pre- and post-petition income and property are “included” in the estate by virtue of § 1115. Therefore, all such property is excepted from the absolute priority rule, such that the rule does not apply in individual Chapter 11 cases.

Like the broad view, the narrow view reads the word “includes” and the word “included” together. However, it reads “includes” narrowly, concluding that a debtor’s post-petition income and property are the only types of property “included” in the estate by virtue of § 1115. Thus, under the narrow view, the absolute priority rule still applies to pre-petition (but not post-petition) assets in individual Chapter 11 cases.

Ninth Circuit Rejects In re Friedman

The Ninth Circuit starts by dismissing the broad view in a cursory fashion. It then turns its focus to the narrow view. Consistent with the narrow view, the Court characterizes the 2005 amendments as merely allowing the debtor to exclude from the absolute priority rule its post-petition property and earnings that would otherwise be included under § 1115.

It gets there by focusing on the word “included” in the phrase “the debtor may retain property included in the estate under section 1115.” Relying on the Sixth Circuit’s opinion in Ice House Am., LLC v. Cardin, 751 F.3d 734, 736 (6th Cir. 2014), the panel agrees that the word “included” better fits as applying to “property that § 1115 takes into the estate” rather than “property that § 1115 contains in the estate.” Thus, the Ninth Circuit concludes that the word “included” only encompasses the post-petition property and earning pulled into the estate by operation of § 1115, and not the property of the estate under § 541 (which Code section is referenced in § 1115).

By excluding the property already in the estate by operation of § 541, the Ninth Circuit found itself espousing the narrow view of the absolute priority rule (and, thus, rejecting Friedman). Like other narrow view courts, the Ninth Circuit also cites the legislative history of the absolute priority rule. And like those other courts, the Ninth Circuit is hesitant to endorse the broad view due to the lack of discussion in the legislative record of any implied repeal of the absolute priority rule. In other words, if Congress wanted to repeal the absolute priority rule in individual cases, then it should have done so explicitly.

Interestingly, the Ninth Circuit at least acknowledges that retaining the absolute priority rule in individual chapter 11 cases “works a ‘double whammy’ on a debtor” because the debtor must devote at least five years disposable income and cannot retain any pre-petition property if the debtor does not pay the creditors in full.

Conclusion 

By our count (which we are in the process of updating),  the Ninth Circuit’s about face on the absolute priority rule in individual cases (and rejection of In re Friedman) means that the debtor-friendly “broad view” is all but dead in the Circuit and Circuit-esque courts. Further, the remaining broad view cases aren’t getting any younger. Indeed, the “narrow view” is the overwhelming view, even if it’s not binding where we practice.

As Zachary shows, the narrow view can have severe consequences for debtors. In fact, the narrow view makes it extremely difficult, if not impossible, for individual debtors to confirm anything other than a consensual plan. However, the Ninth Circuit also points to the consequences for creditors: if the bankruptcy court had confirmed the plan, then the creditor would have received a mere 0.0025% on its claim–even we must admit that a 0.0025% recovery is difficult to sanction. Nevertheless, the narrow view treats a .0025% recovery in the same way that it treats a 99.9975% recovery.

We aren’t done with Zachary v. California Bank & Trust. We disagree with the narrow view and have more to say. In the meantime, check out our Absolute Priority Rule Case Chart–we’re pretty proud of it and, although we think Zachary is dead wrong, we’re grateful for the opportunity to update the list.

If you’d like to stay on top of this issue and other important confirmation issues, then you can subscribe to Plan Proponent via email here.

In drafting a bankruptcy plan, causes of action often appear to be an overlooked step-child. Type A bankruptcy lawyers like us spend hours carefully drafting or dissecting the language on assets, liabilities, potential preferences, plan effective dates, and the like, while spending very little time fleshing out and providing for causes of action held by the estate. While the debtor is required to list causes of action on its schedules and § 1123(b)(3)(B) allows the plan to provide for the retention and enforcement of these causes of action, more often than not, the plan simply provides that the debtor will retain these causes of action, they are not pursued, and they simply die a natural death by means of a statute of limitation.

Sometimes, however, a cause of action is litigated post-bankruptcy and an enterprising defense lawyer will assert that the bankruptcy plan is res judicata. When the judge agrees and dismisses the case with prejudice, the reorganized debtor looks to the bankruptcy lawyer and asks “did you screw up?” Not a good place to be.

Res Judicata in the Bankruptcy Context

With care, this potential pitfall can be avoided. But first, some discussion of the doctrine of res judicata is necessary to understand the issue.

The doctrine of res judicata is designed to require parties to bring the full controversy before the court for resolution. Here in the Eleventh Circuit, the party seeking to apply res judicata must show (1) the prior decision was rendered by a court of competent jurisdiction; (2) a final judgment on the merits; (3) both cases involve the same parties or their privies; and (4) both cases involve the same causes of action. See In re Piper Aircraft Corp., 244 F.3d 1289, 1296 (11th Cir. 2001). The doctrine extends not only to the legal theory presented in the previous litigation, but also to all legal theories and claims arising out of the same “operative nucleus of fact.” See Olmstead v. Amoco Oil Co., 725 F.2d 627, 632 (11th Cir. 1984).

In bankruptcy, the same rule applies to confirmation orders. A bankruptcy court’s order of confirmation is “an absolute bar to the subsequent action or suit between the same parties . . . to every [claim] which might have been presented. In re Justice Oaks II, Ltd., 898 F.2d 1544, 1552 (11th Cir. 1990). The only exception to this general rule is when the cause of action is specifically reserved in the plan of reorganization or in the confirmation order. See D & K Props. Crystal Lake v. Mut. Life Ins. Co., 112 F.3d 257, 260 (7th Cir 1997) (“res judicata does not apply when a cause of action has been expressly reserved for later adjudication”); Browning v. Levy, 283 F.3d 761 (6th Cir. 2002) (“Res judicata does not apply where a claim is expressly reserved by the litigant in the earlier bankruptcy proceeding.”).

Thus, the case law addressing the issue hinges on whether the plan proponent “expressly reserved” the cause of action.

Drafting Retention Provisions

The first point is the plan must expressly state that the reorganized debtor will retain the causes of action. While blindingly obvious, an express reservation of the causes of action is a required starting point.

It is clear that a blanket reservation of all causes of action will not be effective. “The identification must not only be express [i.e., expressly stated] but also the claim must be specific. A blanket reservation that seeks to reserve all causes of action reserves nothing.” D & K Props. at 261.

One potential method to reserve causes of action is by a categorical listing of causes of action. This is especially common when the causes of action arise under Bankruptcy Code provisions such as §§ 544, 547, and 548 and in large cases where there are numerous causes of action. An excellent representative case is In re Pen Holdings, Inc., 316 B.R. 495 (Bankr. M.D. Tenn. 2004). The reorganized debtor brought a preference action after confirming a plan which retained all “Avoidance Actions.” That term was defined as:

“actions and rights of action under Section 510, 541, 544, 545 and 546 of the Bankruptcy Code, all preference claims pursuant to Section 547 . . . , all fraudulent transfer claims pursuant to Section 544 or 548 . . . , all claims recoverable under Section 550 and 553 . . . , all other claims under Chapter 5 of the Bankruptcy Code, and all claims (including claims arising in common law or in equity) against any person on account of any debt or other claim owed to or in favor of the Debtor.”

The plan provided that all causes of action shall vest in the reorganized debtor, and would be distributed in accordance with the terms of the plan. The plan also provided for retention of jurisdiction by the bankruptcy court. The liquidation analysis did not list Avoidance Actions separately, but did include a line item for “other assets” valued at $924,000.

After confirmation, the reorganized debtor filed 173 adversary proceedings to avoid preferential transfers. The defendants asserted that the claims were barred by res judicata.

Pen Holdings emphasized that courts require the plan proponent to specifically describe the causes of action to enable the other parties to the bankruptcy to value the claims and take these amounts into account in voting on the disposition of the debtor’s estate. When the listing is not sufficiently specific, the other parties are unable to make a rational decision. The penalty for the plan proponent’s failure to sufficiently identify the causes of action is to lose the cause of action under res judicata. But compare In re Diabetes America, Inc., 485 B.R. 340, 355 (Bankr. S.D. Tex. 2012) (purpose of retention language under § 1123(b)(3) is to provide notice to potential defendants in order to allow them to calculate liabilities and benefits under a plan).

In the end, Pen Holding held that the preference litigation was sufficiently reserved, but noted that it was “a close case.” In so holding, it noted that “it is not practicable, especially in larger cases, for the debtor to identify by name in the plan or disclosure statement every entity that may have received a preferential payment.” The court also pointed to the Statement of Financial Affairs, which included a list of payment made within the preference period totaling $160,000,000. Other courts to consider avoidance actions agree with Pen Holding’s rationale. See, e.g., Matter of P.A. Bergner & Co., 140 F.3d 1111, 1117 (7th Cir. 1998); In re Kmart Corp, 310 B.R. 107, 124 (Bankr. N.D. Ill. 2004).

Thus, in bankruptcy avoidance actions, it appears to be the rule that categorical retention is sufficient, but certainly the best practice would be to identify as specifically as possible the value of the retained causes of action and disclose that value and the underlying reasoning to creditors.

Pen Holding also illustrated that non-bankruptcy causes of action may be treated differently. It contrasted the “immense” “universe of causes of action that become assets of Chapter 11 estates” with the more limited (and knowable through the Statement of Financial Affairs) universe of avoidance actions. In Browning v. Levy, 283 F.3d 761 (6th Cir. 2002), the Sixth Circuit reviewed a defense of res judicata against state law claims of breach of fiduciary duty, legal malpractice, and other claims. The debtor argued that it expressly reserved “any claims, rights, and causes of action that the Debtor or its bankruptcy estate may hold against any person or entity, including without limitation, claims and causes of action arising under section 542, 543, 544, 547, 548, 550, or 553 of the Bankruptcy Code.” The Sixth Circuit disagreed, stating that “[s]ignificantly, it neither names [the defendant] nor states the factual basis for the reserved claims” and held that res judicata barred the claims.

Conclusion

Of course, the best practice is to list each cause of action and describe the underlying facts. In retaining state law or non-bankruptcy claims, this may even be necessary , at least for the class of claims or the major claims. In that case, it should be sufficient to briefly describe the facts and estimate the claims’ values. But, as the courts have recognized, it can often be impracticable to do so, especially with bankruptcy claims. Thus, at least for avoidance claims, using a categorical approach has been respected by most courts, especially when the plan, disclosure statement, or liquidation analysis contains enough information for third parties to make a reasoned decision on the debtor’s retention of those assets. For all causes of action, it is better to put too much information in a plan or disclosure statement than face the argument that res judicata applies because the bankruptcy pleadings were defective.

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(click the picture to log into ABI and read the Jan. 2016 edition)

We’d like to take a quick moment and plug shamelessly an article that I co-wrote with Richard Gaudet of HDH Advisors, LLC. Our firm does a lot of business with Richard and his group, and he was nice enough to ask me to help out on a topic that we are both quite fond of: cramdown interest rates under Till v. SCS Credit Corp, 541 U.S. 465 (2004). Specifically, we wrote an article for the American Bankruptcy Institute Journal titled “Zero Times Something is Still Zero: Adapting Till to Unsecured Creditors.” The ABI published the article in its January 2016 edition, which hit our mailboxes this afternoon.

The gist of the article is as follows:

First, Till applies to unsecured creditors, not just secured creditors.

Second, the “best interests of creditors test” (i.e., the liquidation analysis) is the starting point for determining whether an unsecured creditor is entitled to risk-based compensation under Till. If the liquidation analysis projects a dividend for an unsecured creditor, then the Till rate should compensate the creditor for the time value of money and risk of default. However, if the liquidation analysis doesn’t project a dividend for an unsecured creditor, then the Till rate should compensate the creditor for the time value of money only, without compensation for the risk of default.

Finally, if the national prime rate is used in a situation where an unsecured creditor is not entitled to compensation for risk, then even the prime rate, by itself, becomes a punitive rate. That is because the prime rate includes all of the risk-based components of an interest rate except for the debtor-specific and term risks. Therefore, risk premiums embedded in the prime rate must be excluded from the Till calculation, in favor of a nominal, time value of money rate (for variable-rate plans) or a treasury bond rate with a term that corresponds to the plan term (for fixed-rate plans).

If you’re an ABI subscriber, then you can read more here: Zero Times Something is Still Zero: Adapting Till to Unsecured Creditors.

And while we’re at it, we might as well cross-reference our prior Till post, located here.

If you’d like to subscribe to Plan Proponent via email, then click here.

 

 

 

DC2

(As is my favorite New Year’s tradition, we’re in DC, but will watch it on TV!)

It’s that obligatory time of the year for “Year in Review” posts and the like. We’re also closing Plan Proponent’s inaugural year. Therefore, from my makeshift office at my in-laws’ home in Potomac, Maryland, here’s our “Best of 2015” post. Happy New Year from Stone & Baxter!

Overview

We started Plan Proponent on February 12, 2015. Looking for an idiot-proof editorial schedule to get us started, and excited about the recently-announced ABI Commission Report, our plan was to blog every confirmation-related section of the Commission Report from its Exiting the Case piece by April 16, 2015, just in time for the kick-off of the American Bankruptcy Institute’s 33rd Annual Spring Meeting in Washington, D.C.–one of the first meetings to profile the Commission Report.

Despite our best efforts, it took us until August 18, 2015 (!) to wrap-up the confirmation-related aspects of the Report, but we had fun trying. Additionally, we had some important distractions along the way, including the May issuance of the U.S. Supreme Court case of Bullard v. Blue Hills Bank (regarding the finality of plan confirmation orders) and the June issuance of the U.S. Supreme Court case of Baker Botts, L.L.P. v. ASARCO, LLC (regarding whether Chapter 11 fee application defense costs are reimbursable). We hit the Baker Botts case hard, and even attracted a short Q&A interview with Jim Christie of Reuters about the impact of the Baker Botts case on Chapter 11 practice.

Overall, 25 out of 36 of our 2015 posts were about the ABI Commission Report. Even the ABI and the Chapter 11 Commission, who were very kind to us on Twitter, must’ve been tired of seeing more posts about the Commission Report. In any event, it was a great way to get us started and we found it very educational–it’s basically a mini-Collier, you know. Strangely though, of our Top 10 posts, the ABI Commission Report didn’t crack the Top 2.

Without further adieu, here are Plan Proponent’s Top 10 most popular posts of 2015. Enjoy!

Our Top 10 Posts of 2015

10. Revisiting § 1129(a)(7)’s “Best Interests of Creditors Test”

Right out of the gate, I’m going to cheat, and reserve our 10th spot for the post that was hands-down the most popular post over the last 30 days. Unlike our top 2 posts, for example, this post has only had days, not months, to incubate. More importantly, it also reflects one of the major aims of this blog: to remind practitioners that the language of the Bankruptcy Code matters. Indeed, it’s amazing what you can learn about bankruptcy by simply picking-up your Code book!

In this post (Tom McClendon’s much-appreciated second post), we remind readers that the “best interests of creditors test” under Section § 1129(a)(7) is designed to provide a projection of liquidation at the individual creditor level (rather than the class level) as of the plan effective date (rather than as of the petition date) for the benefit of impaired, non-consenting creditors (rather than unimpaired, consenting creditors).

9. ABI Commission Report – Section 506(c) and Charges Against Collateral

This wasn’t exactly the most interesting topic, but it’s an important topic, especially for debtor lawyers who spend a good bit of their time dressing-up secured assets for sale, sometimes for a secured creditor’s exclusive benefit.

In a nutshell, the Commission concluded that the “current scope of section 506(c) was appropriate, and that the required nexus between the estate’s expenditures and the secured creditor’s collateral was an appropriate gating feature” of § 506(c). However, the Commission did recommend that § 506(c) should be amended to prohibit a trustee from waivers or stipulations of its § 506(c) rights, as such rights are for the benefit of the entire estate.

You can read more here.

8. Supreme Court Weighs-In on the Finality of Confirmation Orders

In this 2 part post, we took a much needed break from covering the ABI Commission Report and focused on the dead-wrong U.S. Supreme Court case of Bullard v. Blue Hills Bank. In Bullard, the Supreme Court held that, unlike a confirmation or dismissal, an order denying confirmation of a Chapter 13 plan is not final because it doesn’t terminate the “entire process of attempting to arrive at an approved plan.”

Although the Court’s view of finality seems to turn on whether an order results in the sort of “significant consequences” that justify immediate appeal as of right, the Court adopts a rigid rule: Orders approving confirmation are final; orders denying confirmation are not final. We weren’t bashful about our disagreement with this decision–the first of two major (wrong) SCOTUS decisions in 2015.

Part 1: Supreme Court Weighs-In on the Finality of Confirmation Orders (Part 1)

Part 2: Supreme Court Weighs-In on the Finality of Confirmation Orders (Part 2)

7.  ABI Commission Report – Absolute Priority Rule and Plan Gifting Provisions

As it turns out, the so called “absolute priority rule” (APR) got quite a few “hits” this year on Plan Proponent. In this post, we discussed the ABI Commission’s proposed treatment of “plan gifting provisions,” a popular means of encouraging “out of the money” creditors who use the APR to hold a plan hostage to consent to a plan.

Specifically, senior creditors will “gift” or a “tip” (out of their own distributions) the holdout class to achieve consensual confirmation. Although the Commission generally favors “lowering barriers to confirmation of feasible plans,” it’s not in favor of gifting provisions that violate the APR. Read more here.

6. ABI Commission Report – Valuation Issues – “Redemption Option Value”

For some reason, the word “inscrutable” is a frequently-used word in our office. It’s also a good way to describe the ABI Commission’s “Redemption Option Value” proposal. Admittedly, this one took quite some effort to get through. And it was probably at this point in our coverage of the Report that I most felt like our ABI posts were starting to read like junior high book reports! We were summarizing (just shortening?), but were we adding value? We even had to split it into 2 parts. Here’s your reward for finishing part 1: ABI Commission Report – More on “Redemption Option Value”.

All of that said, we were pleased when Konstantin Danilov and Chis Feige of Analysis Group, Inc. came across our ROV posts. Konstantin and Chris wrote their own ROV article for the Association of Insolvency & Restructuring Advisors Journal. It’s an excellent article and gives the ROV concept the technical treatment that it deserves. (And for all of you lawyers out there wondering whether having a “blawg” is worth it–Konstantin, who only learned about us through Plan Proponent, was nice enough to ask us whether we’d be interesting in writing an AIRA Journal article.

5. ABI Commission Report – Section 552(b) and the “Equities of the Case”

To recap, Section 552(b) addresses the effect of pre-petition liens on post-petition property. Section 552(a) states the general rule: post-petition property is not subject to a pre-petition lien. Section 552(b) states two exceptions: a pre-petition lien continues as to post-petition proceeds and post-petition rents from pre-petition collateral. In turn, the two exceptions are subject to an exception: the court, after notice and a hearing, can treat the pre-petition lien differently based on the “equities of the case.” This post ended-up being more interesting to readers than we expected.

(The most interesting part of the Commission’s analysis of Section 552(b)’s “equities of the case” exception is its focus on the recent Residential Capital decision–an enormous, 117 page opinion by Judge Glenn which reads like a treatise on cash collateral and valuation issues, among other issues. You might just want to skip our post and read Res Cap!)

4. ABI Commission Report – Third-Party Releases in Plans

In this post, we discussed the extent to which third-party releases in Chapter 11 plans are enforceable. Arguably, the most useful tidbit that we provided was the summary of the case split on third-party releases (compliments of the 11th Circuit in SE Property Holdings, LLC v. Seaside Engineering & Surveying, Inc., our favorite 2015 11th Circuit case):

  • “Pro-Release” Circuits (Majority View): 2nd, 3rd, 4th, 6th, 7th, 11th (and likely the 1st and D.C.) Circuits
  • “Anti-Release” Circuits (Minority View): 5th, 9th, and 10th Circuits

3. ABI Commission Report – Cramdown Interest Rates

This post provided us an excuse, via the ABI Commission Report, to give an overview of our favorite business bankruptcy topic: cramdown interest rates under Till v. SCS Credit Corp, 541 U.S. 465 (2004). It also provided an excuse for us to link over to Version 14 (!) of Weil Gotshal’s Cramdown Interest Rate Table (the most useful bankruptcy case chart we’ve ever seen and the inspiration for our “absolute priority rule” case chart, which is up next).

2. David Cassidy and the Absolute Priority Rule

In this post, we asked whether Partridge Family member David Cassidy’s Chapter 11 bankruptcy case in the Southern District of Florida might help resolve the most controversial plan confirmation issue in individual Chapter 11 cases: the “absolute priority rule” (APR). The APR is our favorite individual debtor topic because it arguably gets at the right of an individual to reorganize under Chapter 11. However, we limited our post to (1) introducing the APR, (2) framing the split of authority regarding its application, and (3) linking readers to our APR Case Chart.

[Note to Tom: If you’re looking for a 2016 post idea, then let’s update this one!]

And the winner is…

1. Delaware Takes on Baker Botts v. ASARCO & Fee-Defense Costs

Our 3 posts on the Baker Botts case were in the Top 8 of all of our posts for 2015 and the Delaware post was, by far, the most popular post of 2015. It might’ve been the pretty picture of the Baha Mar resort or it might just be the riveting topic of fee defense costs. Who knows. In any event, we really enjoyed drilling down on this important case.

In short, on June 15, a 6-3 Supreme Court held that bankruptcy professionals employed under Section 327(a) of the Bankruptcy Code may not, under Section 330(a)(1) of the Bankruptcy Code, recover as compensation fees incurred in defending their bankruptcy fee applications. In turn, the United States Trustee in Delaware has filed a slew of ASARCO-themed objections in some large Delaware cases (i.e., does Section 328(a) provide an ASARCO workaround by permitting debtors to agree, up-front, in the engagement letter to pay fee defense costs?). The Delaware courts do not appear to have ruled yet, but we’ll keep you posted in 2016 when those decisions come down.

Here’s a link to the combined post (a convenient .pdf of our Baker Botts Q&A) that kicked-off our Baker Botts coverage: Click Here. The individual links:

20 Questions about Baker Botts v. ASARCO & “Fee-Defense” Costs – Part 1

20 Questions about Baker Botts v. ASARCO & “Fee-Defense” Costs – Part 2

Finally, we capped-off our Baker Botts coverage in 2015 with a quick Q&A with Reuters. Kinda cool.

Conclusion

And that’s it for 2015. Thanks for following! We hope you enjoyed our posts. We’ve got some “exciting” things planned for 2016–things that we simply didn’t have the bandwidth to implement this year. Until then, Happy New Year!