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Whether Letter's of Credit are Property of the Estate

The Court in S-Tran did not have to look far for case law regarding the treatment of letters of credit in the bankruptcy context.  In 2006, Judge Walsh issued an opinion in Oakwood Homes recognizing the "well established" rule that letters of credit, and the proceeds they generate, are not property of the estate.  OHC Liquidation Trust v. Discover Re (In re Oakwood Homes Corp.), 342 B.R. 59, 67 (Bankr.D.Del. 2006).  However, citing the Third Circuit, the court in Oakwood Homes also held that "the collateral pledged as a security interest for the letter of credit is [property of the estate]."  Id., citing Int'l Fin. Corp. v. Kaiser Group Int'l Inc. (In re Kaiser Group Int'l Inc.) 399 F.3d 558, 566 (3d Cir. 2005)(citations omitted).

Applying Oakwood and Kaiser, the Court in S-Tran found that the issuers of the letters of credit paid S-Tran's insurer the proceeds of the letters of credit, which the insurer then used to pay third parties and create a reserve account.  "Because the letter of credit proceeds were not paid with or secured by the Debtors' property, the fact that the proceeds were paid prior to the bankruptcy filing does not transform those entire proceeds into property of the estate."  S-Tran Holdings, et al., v. Protective Insurance Company, at *8, Adv. No. 07-51341, Oct. 5, 2009 (Bankr. D.Del.).

Conclusion

Like the debtor in Oakwood Homes, S-Tran sought to recover the proceeds from the letter of credit under section 542 of the Bankruptcy Code alleging claims for turnover of estate property.  However, like the court in Oakwood Homes, the Court in S-Tran held that section 542 is a remedy that is available only for debtors seeking to recover what is acknowledged to be estate property.  Section 542 is not appropriate, however, if a debtor seeks to recover claims that remain unliquidated or in dispute.  Although S-Tran might have a claim for excess letter of credit proceeds, the Debtor cannot recover such excess under section 542 until the amount of the claim has been liquidated.

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Jason Cornell is a bankruptcy attorney in Wilmington, Delaware with the law firm Fox Rothschild LLP.  If you have questions regarding a Delaware bankruptcy proceeding, you may contact Jason at 302 427-5512, or jcornell@foxrothschild.com.

Two Different Auctions

For the sake of clarity, the auctions referenced in this post will be named "Short Auction" and "Long Auction," referring to time required to complete each auction.  Short Auction was part of a chapter 11 bankruptcy of a multi-national corporation with assets valued in the hundreds of millions of dollars.  Short Auction involved the sale of a large piece of commercial real estate, whereas Long Auction involved the sale of the debtor's entire business.  The debtor selling assets in the Long Auction also filed under Chapter 11, however, its total assets were a fraction of the size of the debtor involved in the Short Auction.

Short Auction began at 8:00 in the morning at the Delaware offices of the debtor's attorney.  Several parties were present at the auction, including representatives for the two bidders for the debtor's asset and counsel for the debtor.  A court reporter was also present to make a record of the auction process.  Long Auction, in contrast, started at 8:00 p.m. and included counsel for the creditors' committee, debtors and counsel for the bidders.  In Short Auction, a successful bidder emerged within 30 minutes of the commencement of the auction.  Long Auction, on the other hand, went late in the night and was adjourned for several days while bidders explored additional financing.

Take Aways from Both Auctions

Why was Short Auction short and Long Auction long?  The answer is rather straight forward - Short Auction involved the sale of a small component of the debtor's overall business, whereas Long Auction sought to sell all of debtor's business.  Further,  the buyers in Short Auction came to the table with cash compared to the Long Auction that included credit bids and other contingencies that complicated the process. 

In Short Auction, there was only one "break out session" where a bidder sought higher authority from a decision maker who was available by phone.  Long Auction, on the other hand, had several break out sessions, some lasting close to an hour.  The point of all this is that auctions in bankruptcy vary as to duration and result, however, at the end of the day parties will want to make sure the auction was fair and the result of arms-length negotiations (as was the case in both Short and Long Auctions).   And although the debtor's decision to sell its assets outside the ordinary course of business fall under the broad discretion of the business judgment rule,  the Bankruptcy Court will nevertheless scrutinize the successful bid to insure that it is in the best interest of the bankruptcy estate and the result of a good faith negotiations by the parties.

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Jason Cornell is a bankruptcy attorney in the Wilmington, Delaware office of Fox Rothschild LLP.  If you have questions regarding a chapter 7 or 11 bankruptcy proceeding, you are welcome to contact Jason at 302 427-5512, or Jcornell@foxrothschild.com.

Barzel's cost-cutting measures were not enough and in May of this year, the company missed an interest payment due on its Senior Secured Notes, two-thirds of which are held by JPMorgan Chase.  With few options remaining, Barzel began looking for potential purchasers of the company.  As a result of its marketing efforts, 72 parties executed confidentiality agreements and 12 made offers to pursue a purchase transaction.

On September 14, 2009, Barzel entered into an asset purchase agreement with Chriscott USA Inc. and 4513614 Canada.  Under the APA, Barzel will sell substantially all of its assets for $65 million unless a better offer comes about through the bankruptcy auction process.  Barzel's lenders have agreed to finance its bankruptcy proceeding through December 11, 2009, while Barzel completes the auction process. 

According to Barzel's Bankruptcy Petition, its assets total $365 million against debts totaling $384 million.  This bankruptcy is before the Honorable Christopher S. Sontchi.

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Jason Cornell is a bankruptcy attorney with Fox Rothschild LLP in Wilmington, Delaware.  If you have questions regarding this or any other bankruptcy proceeding, you may contact Jason at 302 427-5512, or jcornell@foxrothschild.com. 

 The Elements of a Preference Action

Congress provides a debtor in bankruptcy with a cause of action for preference payments pursuant to section 547(b) of the United States Bankruptcy Code.  Under section 547(b), a debtor in bankruptcy may "avoid any transfer of an interest of the debtor in property (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the debtor for such transfer was made; (3) made while the debtor was insolvent; (4) made (A) on or within 90 days before the date of the filing of the petition ..." 

Mere Conduit Defense

Congress also provided parties who received alleged "preference payments" with several defenses.  The "mere conduit" defense is set forth under section 550(a)(1) of the Bankruptcy Code and provides an exception to a debtor's ability to recover preferential transfers:

Except as otherwise provided in this section, to the extent a transfer is avoided under section ... 547 ... the [debtor] may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from -

(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made ... 

Application of the Mere Conduit Defense

Courts deciding whether to apply the mere conduit defense look to whether the defendant who allegedly received the preferential transfers had "dominion and control" over the payments.  U.S. Interactive v. Sampson Travel Agency (In re U.S. Interactive), 321 B.R. 388, 395 (Bankr. D. Del. 2005).  For a defendant to establish the mere conduit defense, it must show that the payments received from the debtor "merely slipped through his hands to another party."  Id., citing Bailey v. Big Sky Motors, Ltd. (in re Ogden), 314 F.3d 1190, 1196 (10th Cir. 2002);  see also, Christy v. Alexander & Alexander of New York Inc., (In re Finley, et al.), 130 F.3d 52, 58 (2d Cir. 1997).  If the defendant had the right to put the money to its use as it saw appropriate, the mere conduit defense does not apply.  Official Comm. of Unsecured Creditors v. Guardian Ins. 401 (In re Parcel Consultants, Inc.), 287 B.R. 41, 46 (Bankr. D. N.J. 2002).

In U.S. Interactive, the court found that the defendant, a travel agent, did not satisfy the mere conduit defense because the defendant was able to deposit the funds into its own checking account and do with the money as it saw fit.  Instead, what is required to satisfy the mere conduit defense is evidence that the initial recipient of the payments lacked the power to decide who to pay with the funds.  The decision in U.S. Interactive suggests that if the initial recipient of the money received from the debtor is required to deposit the funds in a separate account (versus its general operating account), and those funds are subsequently forwarded to a third party, the defense may apply. 

Conclusion

Clearly, the mere conduit defense has limited application to parties who are defending a preference action.  However, for those defendants whose circumstances show they lacked "dominion and control" over the payments, and instead forwarded the payments to a third party,  the defense can be a valuable tool in reducing or eliminating exposure in a preference action.

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Jason Cornell is an attorney who practices in Fox Rothschild's Wilmington, Delaware office.  If you have questions regarding this, or any other bankruptcy matter, you may contact Jason directly at 302 427-5512, or jcornell@foxrothschild.com.  Please be advised that Fox Rothschild LLP does not represent Whitehall Jewelers in this bankruptcy proceeding.  Click here if you would like to read other posts on this blog regarding issues that arise in preference litigation.

Debtor's Operations

Freedom Communications' origins go back to 1935 when R.C. Hoiles purchased The Orange County Register.  From its beginnings through 2000, the company purchased newspapers and other publications in the states of Arizona, California, Colorado, Florida, Illinois, Indiana, Missouri, New Mexico, North Carolina, Ohio and Texas.  According to Freedom's Declaration, as of its petition date, the company owns 90 daily or weekly publications and 30 daily newspapers.  In addition to print publications, Freedom also owns eight television stations, most of which are either ABC or CBS affiliates.  Including contractors, Freedom employs over 8,200 individuals.

Debtor's Financials

Freedom lists its assets with a book value of $757 million, against liabilities totaling over $1 billion.  Included in Freedom's debt is its credit agreement of approximately $770 million.  The remaining $306 million in liabilities includes trade claims, contract claims, lease claims, non qualified retirement plan claims and litigation claims.  According to Freedom's Petition for Bankruptcy, the company's ten largest unsecured creditors include:

1. JP Morgan (unsecured loan) ... $770 million
2. Class Action Plaintiffs ... $28.9 million
3. Kingworld Productions, Inc. ... $1.5 million
4. North Pacific Paper ... $1.2 million
5. Bowater America, Inc. ... $753,326
6. Inland Empire Paper ... $590,502
7. SP Newsprint  Co. ... $548,151
8. Vertis Inc. ... $381,416
9. Impression Inks West ... $374,591
10. Abitibi Consolidated Sales ... $356,630

Conclusion

This bankruptcy proceeding is before the Honorable Brendan L. Shannon.  There has been substantial activity in this case within the first 24 hours of the petition date.  Included among the company's "first day" bankruptcy motions is a motion to pay certain critical vendors, a motion seeking administrative claim status of postpetition goods and a motion to establish procedures for the rejection of executory contracts and leases.  (To read a prior post on issues relevant to lease rejection, click here).

Many debtors file for bankruptcy in an effort to sell-off assets under the protection of section 363 of the United States Bankruptcy Code.  Freedom states in its Declaration that it filed for bankruptcy in order to restructure its debt under a plan of reorganization.  To that end, the company intends to file a disclosure statement and plan of reorganization within 45 days from the date it filed for bankruptcy.

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Jason Cornell is a bankruptcy attorney who practices in Wilmington, Delaware with Fox Rothschild LLP.  If you have questions regarding this or any other Delaware bankruptcy proceeding, you may contact Jason at 302 427-5512, or jcornell@foxrothschild.com.  Fox Rothschild LLP does not represent Freedom Communications Holdings in this bankruptcy proceeding.

Debtor's Business

According to Proliance's Declaration in Support of First Day Motions (the "Declaration"), the company's origins go back to 1915 when it began manufacturing radiators for automobiles and fire engines.  Proliance today is the product of a merger between Transpro Inc. and Modine Aftermarket Holdings, Inc..  There are two primary component's to the Debtor's business - domestic and international operations. 

On February 5, 2008, a tornado destroyed Proliance's domestic distribution center in Southaven, Mississippi.  The tornadoes ruined a substantial portion of Proliance's auto and truck heat exchange inventory.  With the loss of this inventory, Proliance encountered "severe liquidity constraints" which the company views as "one of the major precipitating factors for these cases."  See Debtors' Declaration at p. 5.

Debtor's Financials

Within the U.S., Proliance is one of the largest manufacturers of heat exchange products.  The company list net sales for 2008 of $350 million.  According to the Declaration, sales for 2008 were down 11.1% when compared to 2007.  The Debtor attributes most of its drop in sales in 2008 to the destruction of its Mississippi distribution center. 

In 2007, Proliance entered into a prepetition credit agreement with Silver Point Finance as administrative agent and collateral agent for the prepetition lenders.  Although the prepetition credit facility provides up to $100 million in debt, going into bankruptcy the company owed $33.6 million under a term loan and $6.5 million under a revolving loan facility.  

The Debtor estimates its trade debt totals $51.7 million.  This amount includes moneys owed to both domestic and foreign vendors.  According to Proliance's Bankruptcy Petition, its ten largest unsecured creditors include the following:

1. Enterex Industrial ... $17.1 million
2. Transtec Global ... $11.8 million
3. U&C Auto Parts ... $2.6 million
4. Alcoa Mill Products ... $1.8 million
5. Luvata Netherlands ... $1.3 million
6. Foshan Guang Dong Automotive ... $1.2 million
7. President Automotive Industries ... $1.2 million
8. Lumei Auto Radiator ... $1.1 million
9. Sapa/Norca Heat Transfer ... $918,685
10. Tianjin Xinyue Auto Part Co. ...$878,026 

The company lists total assets of $160 million against debts totaling $133 million.

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Jason Cornell is a bankruptcy attorney with the law firm Fox Rothschild LLP in Wilmington, Delaware. If you have questions regarding this or any other Delaware legal proceeding, you may contact Jason at (302) 427-5512 or jcornell@foxrothschild.com.

Commencement of the Meeting

The U.S. Trustee presiding over Delaware bankruptcies generally holds meeting of creditors in a meeting room on the second floor of the J. Caleb Boggs Federal Building.  Notices of the meeting of creditors are prepared by the Trustee and filed with the Court.  A copy of the notice in the Magna Entertainment bankruptcy is attached here. 

In the Magna Entertainment 341 meeting of creditors, the Trustee commenced the meeting by identifying himself and the representatives of the Debtor.  Magna had three representatives participating in the meeting - its bankruptcy counsel, the CFO and its general counsel.  Before the CFO and counsel spoke at the meeting, they were sworn-in by the Trustee.  As required under Rule 2003(c), the Trustee recorded the "examination under oath ... using electronic sound recording equipment ..."

The Trustee's Questions for the Debtor

The U.S. Trustee began his questioning of the Debtor's representative by confirming who prepared and signed Magna's schedules and statement of financial affairs.  Magna's CFO stated that he reviewed the various statements and schedules, however, the documents were prepared with the assistance of Alix Partners, one of Debtor's advisers. 

The Trustee's questions in the Magna meeting of creditors were similar to other meetings.  Many of his questions focused on the structure of Magna and its various debtor-entities.  For example, the Trustee asked Magna's representatives to explain the relationship of Magna as parent to various Debtor subsidiaries.  Some of the Trustee's questions focused on the extent of the parent company's operations, revenue and payroll.

The Trustee's questions also addressed Magna's secured debt and tax liability.  Here, the Trustee asked the Debtor to explain claims of insiders and whether Magna was current on its taxes.  The Trustee also asked Magna's professionals to state whether Magna had learned of any inaccuracies in its schedules and financial statements after they filed the documents with the Court. 

Other questions asked by the Trustee included:

• How were employee bonuses determined and paid by Magna;
• What certain account receivables consisted of;
• Magna's collective bargaining agreements and other executory contracts;
• Insiders for each of Magna's debtor-entities; 
• Magna's management structure;
• Why some debtor-entities had little or no assets;
• Whether Magna experienced any changes in revenue since filing for bankruptcy;
• Whether insurance remained active;
• Whether Magna continues to pay employee wages and benefits;
• Why Magna filed for bankruptcy; and,
• Magna's long term plan while in bankruptcy and after it emerges from bankruptcy.

Conclusion

Magna's meeting of creditors ended with counsel for two creditors asking Magna's professionals questions that were specific to their particular clients.  One creditor asked whether Magna had made a decision to assume or reject particular contracts.  Another creditor, a municipality, asked Magna questions regarding specific leases and related contracts relative to property located within the municipality. 

By most standards, Magna's meeting of creditors was uneventful.  The meeting lasted approximately two hours, the majority of which consisted of the Trustee asking questions about Magna's businesses.  The meeting provides a good idea of some of the questions a debtor might encounter during a meeting of creditors. Equally important, the Magna meeting of creditors provides creditors with an idea of what to expect in future meetings in other bankruptcies.

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Jason Cornell is a bankruptcy attorney at the law firm Fox Rothschild LLP in Wilmington, Delaware. If you have questions regarding this, or any other Delaware legal proceeding, you may contact Jason at (302) 427-5512 or jcornell@foxrothschild.com.