Delaware Bankruptcy Litigation : Delaware Bankruptcy Lawyer & Attorney : Fox Rothschild Law Firm : Financial Restructuring & Bankruptcy Litigation

Events Leading to Bankruptcy

Manistique attributes its bankruptcy to the increased costs of raw materials compounded by a substantial drop in sales.  According to the company, the cost of raw materials increased by one million dollars each month since January of 2011.  Decl. at *5.  During this same time period, sales for Manistique's products dropped by approximately 30%.  The company also contends that the lack of payment by one of its larger costumers further aggravated the company's already volatile economic condition. Id.  A copy of Manistique's Declaration is available here for review.

Objectives in Bankruptcy

One of the first motions Manistique filed with the Bankruptcy Court is its Motion for Interim and Final Orders Authorizing Use of Cash Collateral (the "Cash Collateral Motion").  Manistique owes is prepetition secured lender approximately $11.1 million.  The company's lender has a lien on all of Manistique's assets - including cash collateral.  In order to continue with its day to day operations, Manistique seeks an order from the Court allowing it to access its cash collateral.  According to Manistique, "[p]reserving, maintaining, and enhancing the value of the Debtor's business assets is of the utmost importance to a successful sale." (Emphasis added). Decl. at *22-23.

The Manistique bankruptcy is before Judge Kevin J. Carey.  Judge Carey is Chief Judge of the Delaware Bankruptcy Court.  Manistique is represented by the Delaware law firm Morris, Nichols, Arsht & Tunnel LLP. 

For those readers who are unfamiliar with the bankruptcy process, below are some of my prior posts that address common issues that arise in Delaware bankruptcy proceedings: 

Ten Things Every Commercial Landlord Should Know About a Tenant in Bankruptcy;

What to Expect in a Section 341 Meeting of Creditors;

A Closer Look at Chapter 11 Bankruptcy Auctions; and,

Subject Matter Jurisdiction of the Bankruptcy Court.

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Jason Cornell is an attorney with the law firm Fox Rothschild LLP and practices before the United States Bankruptcy Court for the District of Delaware.  You can reach Jason at (302) 427-5512 or jcornell@foxrothschild.com.

Equitable Power of the Court

Under section 105(a) of the Bankruptcy Code, a bankruptcy court can "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title."  In its motion, Petroflow cites to an Eighth Circuit decision for the proposition that "the overriding consideration in bankruptcy ... is that equitable principles govern."  In re NWFX, Inc., 864 F.2d 588, 590 (8th Cir. 1988).  However, a bankruptcy court's equitable jurisdiction has its limits.  Again, looking at the Petroflow motion, the Debtor cites In re Cooper Props. Liquidating Trust, Inc., for its holding that a bankruptcy court must protect the equities of a debtor "as long as that protection is implemented in a manner consistent with the bankruptcy laws."  61 B.R. 531, 537 (Bankr. W.D. Tenn. 1986)(emphasis added).

Petroflow's motion seeks entry of an order finding that the first day orders in the "First Filed Cases" apply to the Petroflow bankruptcy.  Without this relief, Petroflow would have to seek the same relief granted in the North American Petroleum and Prize Petroleum cases, which in turn would create an unnecessary burden on Petroflow, its creditors and the Court.  In support of its motion, Petroflow cites to other bankruptcy proceedings where similar orders were entered by the Court.  These bankruptcy proceedings include Semcrude, Chi-Chi's, Lehman Bros. and WorldCom.

As I mentioned before, there is nothing extraordinary about the relief sought by Petroflow.  The motion is worth review, however, as it is provides an example of how parties can invoke the equitable jurisdiction of the Court under section 105 of the Bankruptcy Code. 

The Petroflow bankruptcy is before the Honorable Christopher S. Sontchi.  Click here to read my post from May of this year discussing the North American Petroleum bankruptcy.  That post looks at why the company filed for bankruptcy, as well as what the company's objectives are while in bankruptcy.

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Jason Cornell is a bankruptcy attorney with Fox Rothschild LLP.  Jason practices in Fox Rothschild's Wilmington, Delaware office. You can reach him at 302 427 5512, or jcornell@foxrothschild.com. 

Events Leading to Bankruptcy

Approximately 80 of Debtors stores are "losing money at an unsalvageable rate."  See Declaration at *12.  In response, Debtors intend to either reject the leases of the unprofitable stores or seek rent reductions from landlords.   The company has been operating with negative earnings for several months which it attributes to poor market conditions and a resulting drop in sales.  Debtors contend that many of their store leases have either above-market rent prices or "inappropriate store locations."  Id. at *13. 

Conclusion

By filing for bankruptcy, Debtors hope to implement a "large scale restructuring that will eliminate unprofitable locations and result in a viable entity going forward ..."  Declaration at *15. To achieve their objective, Debtors will seek court approval of auction procedures that will allow Debtors to sell off assets soon.  Debtors are motivated to exit bankruptcy for various reasons, one of which is to control the loss of employees to competitors.  Id. at 17. 

This bankruptcy proceeding is before the Honorable Kevin Gross of the United States Bankruptcy Court for the District of Delaware.  Debtors are represented by Young Conaway Stargatt & Taylor, LLP.

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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 another Delaware bankruptcy proceeding, you may contact Jason at 302 427 5512, or jcornell@foxrothschild.com.

Goody's Second Bankruptcy Filing

Goody's emergence from bankruptcy was short lived.  On January 13, 2009, the reorganized Goody's filed another petition for bankruptcy in Delaware.  Goody's second bankruptcy, also filed as a chapter 11 reorganization, began only three months after the company's plan of reorganization was approved by the Court in the first bankruptcy proceeding. 

The Preference Actions

The preference actions recently filed by the Plan Administrator seek the recovery of transfers made prior to the commencement of the first bankruptcy proceeding.  According to recent court filings, the Plan Administrator filed the preference actions in an effort to offset any avoidable transfers against  allowed claims under section 503(b)(9) of the Bankruptcy Code.  These adversary actions, along with both of Goody's bankruptcy proceedings, are before the Honorable Christopher S. Sontchi.  Click here to review a prior post from this blog discussing a decision by Judge Sontchi in the Goody's bankruptcy proceeding.

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Jason Cornell is an attorney in the Wilmington, Delaware office of Fox Rothschild LLP.  Jason's practice focuses primarily on corporate bankruptcy and civil litigation.  He may be reached at 302 427 5512, or jcornell@foxrothschild.com

Events Leading to Bankruptcy

Towards the end of 2008, the Debtor experienced an increase in "doubtful accounts" on its books, which in turn led to three covenant violations under various loan agreements.  Following the covenant violations, the Debtor's first lien lender cut access to a revolving line of credit.  Once Chem Rx's vendors learned of the company's covenant violations, they began limiting trade credit.  According to the Declaration, Debtor's trade credit was reduced by more than $15 million in 2009.  See Declaration at *10.

Objectives in Bankruptcy

Chem Rx's loss of trade credit with its vendors, compounded by the loss of liquidity with its lenders, forced the company to reduce costs and eliminate certain expenditures.  Despite such efforts, the company could not meet its debt obligations with its prepetition lenders.  During the year prior to bankruptcy, Chem Rx and its lenders tried unsuccessfully to restructure the company's debt out of court.  Also during this time, the Debtor was approached by a potential purchaser, however, negotiations eventually stalled. 

In March of this year, Chem Rx's first lien lender advised the Debtor that it would agree to a consensual reorganization under chapter 11.  Under a negotiated term sheet, Chem Rx agreed to hire an investment banker to assist with the marketing and sale of the business.  However, should no offers materialize that are acceptable to the first lien lender, the lender would receive all of the Debtor's equity in a reorganized company. 

This bankruptcy proceeding is before the Honorable Mary F. Walrath, former Chief Judge of the United States Bankruptcy Court for the District of Delaware.  For a better understanding of this proceeding,  a copy of the Debtor's First Day Declaration is available here.  Further, a copy of the Debtor's bankruptcy petition is available here.

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Jason Cornell is a partner with the law firm Fox Rothschild LP in Wilmington, Delaware.  You can reach Jason at 302 427 5512, or jcornell@foxrothschild.com.

Analysis

After discussing the facts underlying the case and the standard for summary judgment, the Court turned to the elements and policy behind the OCB defense.  The Court began by noting the two reasons behind the OCB defense:  encourage creditors to continue dealing with distressed debtors and promote the equal treatment of distribution among creditors.  Fiber Lite Corp. v Molded Acoustical Products, Inc. (In re Molded Acoustical Products, Inc.), 18 F.3d 217, 219 (3d Cir. 1994).  Because Pillowtex filed for bankruptcy prior to the amendments to section 547(c)(2),  Classic was required to prove all three elements of the defense.  Section 547(c)(2) protects from avoidance those transfers that are:

(A)  in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee;

(B)  made in the ordinary course of business or financial affairs of the debtor and transferee; and,

(C)  made according to ordinary business terms.

The Plaintiff argued that Classic could not show there were no material factual issues regarding section 547(c)(2)(B) and (C).  The Court first looked at the OCB defense under section 547(c)(2)(B), commonly referred to the "subjective test."  The question for the Court under the subjective test is to "determine the consistency of transactions between the parties before and during the preference period."  Opinion at *9, citing SEC v. First Jersey Sec., Inc. (In re First Jersey Sec., Inc.), 180 F.3d 504, 512 (3d Cir. 1999).  To determine whether transactions between the creditor and debtor are consistent before and during the 90 day preference period, courts consider the following:

1. the length of time the parties have engaged in the type of dealing at issue;
2. whether the subject transfer was in an amount more than usually paid;
3. whether the payments were tendered in a manner different from the previous payments;
4. whether there appears any unusual action by either the debtor or the creditor to collect or pay on the debt; and
5. whether the creditor did anything to gain an advantage (such as gain additional security) in light of the debtor's deteriorating financial condition.

Opinion at *9, citing HLI Creditor Trust v. Metal Tech. Woodstock Corp (In re Hayes Lemmerz, Int'l, Inc.), 339 B.R. 97, 106 (Bankr.D.Del. 2006).  The defendant, Classic, argued that the Debtors always paid Classic in a timely manner, with some exceptions, and that the payments made during the preference period continued in a timely manner.  Opinion at *11.  Plaintiff, on the other hand, argued that Debtors started paying Classic more quickly during the preference period, with some payments as early as two days after invoice.  Opinion at *12.  After considering the parties' arguments, the Court found that Classic failed to prove that no genuine issues of material fact exist.  Id.

Having considered Classic's "subjective" prong of the ordinary course defense, the Court next turned to the "objective" prong of the test under section 547(c)(2)(C).  The objective test requires the Court to determine whether "the business terms between the Debtors and Classic were ordinary in the industry ..."  Opinion at *13.  Classic argued, and the Court agreed, that in proving the objective prong (aka the "industry standard") of the ordinary course of business defense,  Classic can rely on the testimony from employees of the parties involved in a preference payment dispute.  Id.  citing Troiso v. E.B. Eddy Forest Products (In re Global Tissue LLC), 106 Fed. Appx. 99, 103 (3d Cir. 2004). 

Because the Court found that there was a factual dispute under the subjective prong of the ordinary course of business defense, the Court declined to decide whether terms that existed between the Debtors and Classic were ordinary in the industry.  Opinion at * 14.  Further, because summary judgment was not appropriate, the Court declined to decide whether Classic's witnesses were qualified to testify.  Id.

Conclusion

With the high volume of preference actions filed in the Delaware Bankruptcy Court each year, decisions addressing the ordinary course of business decision always provide value.  In Pillowtex, the Court makes an interesting point in footnote *9.  Classic argued that the facts presented through its motion for summary judgment were similar to those in Montgomery Ward LLC v. OTC Int'l, Ltd. (In re Montgomery Ward, LLC), 348 B.R. 662 (Bankr.D.Del. 2006).  In Montgomery Ward, the court found that the ordinary course of business defense applied even though there was a change in payment terms before and during the preference period.  Montgomery Ward, 348 B.R. at 679.  The distinction between Classic's defense in Pillowtex and that of the defendant in Montgomery Ward was that Montgomery Ward was decided after a trial that included "detailed findings of fact by the Judge regarding the parties' business relationship."  Opinion at *13. 

The Court's comments in footnote *9 make an interesting point regarding preference litigation - these cases often involve factual disputes that are not able to be resolved through summary judgment.  As the Court observed in Pillowtex, when the court is deciding a motion for summary judgment, "it is not the role of the judge to weigh the evidence or to evaluate its credibility, but to determine 'whether there exists a genuine issue for trial.'"  Opinion at *7, citing Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed. 2d 202 (1986).  By its very nature, the ordinary course of business defense requires the Court to weigh evidence - whether payments made before and during the preference period were similar as to the parties and as to the relevant industry. 

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Jason Cornell is a bankruptcy attorney at Fox Rothschild in Wilmington, Delaware.  You may reach Jason at 302 427-5512, or jcornell@foxrothschild.com.

Bankruptcy and the Proposed Plan

Spansion filed for bankruptcy in Delaware on March 1, 2009.  By October of 2009, the Debtor, the Official Committee of Unsecured Creditors (the "Committee") and certain secured noteholders agreed to a consensual plan of reorganization.  By November, however, the Committee withdrew its support for the plan and the parties continued with negotiations.  In late December, Spansion filed a Second Amended Joint Plan (the "Plan"), and the Bankruptcy Court thereafter approved the Disclosure Statement and scheduled a plan confirmation hearing. 

In considering the various objections to the Plan, the Court began its analysis by recognizing that in order for the Plan to be confirmed, it must comply with section 1129 of the Bankruptcy Code.  Citing the Court's decision in Exide Technologies, Judge Carey observed:

The plan proponent bears the burden of establishing the plan's compliance with each of the requirements set forth in section 1129(a), while the objecting parties bear the burden of producing evidence to support their objections.  In a case such as this one, in which an impaired class does not vote to accept the plan, the plan proponent must also show that the plan meets the additional requirements of section 1129(b), including the requirements that the plan does not unfairly discriminate against dissenting classes and the treatment of the dissenting classes is fair and equitable.  In re Exide Tech., 303 B.R. 48, 58 (Bankr.. D. Del. 2003)(internal citations omitted).

One of the issues presented to the Court concerned whether the Debtor had under-valued its business under the Plan, to the detriment of unsecured creditors.  During the confirmation hearing, the Court heard testimony from three different expert witnesses on value (one expert for the Debtor and two experts for other interested parties).  In calculating their values of the company, the Court found that each expert used "customary valuation methodologies:  discounted cash flow analysis, publicly traded company analysis and comparable M&A transaction analysis."  Opinion at *24. 

After considering the testimony of each expert, the Court found that the valuation offered by the senior noteholders, not the Debtor's expert, "was appropriately weighted and rested on assumptions that, of the three [expert] reports, were the most sound for determining the Debtors' worth at this time and in this industry."  Opinion at *33.  The Court preferred the noteholders' valuation over the Debtor's because it found the valuation "more transparent" and "more in line with common valuation practices."  Id.

The Court next looked at whether the "Equity Incentive Plan" offered in the Plan was reasonable and proposed in good faith.  Here the Court noted that the "point of inquiry" to determine whether a plan is offered in good faith under section 1129(a)(3) is "whether such a plan will fairly achieve a result consistent with the objectives and purposes of the Bankruptcy Code."  Opinion at *35, citing In re PWS Holding Corp., 228 F.3d 224, 242 (3d Cir. 2000). 

Hearing arguments for and against the Incentive Plan, and weighing the Debtor's testimony in support of the Incentive Plan, the Court found that the record did not "demonstrate sufficiently that the Equity Incentive Plan is usual or reasonable for this market at this time."  Opinion at *38.  In order for Spansion's Plan to be confirmed, the Court concluded that Spansion must "devise an incentive scheme that garners uniform support from its constituencies or is demonstrably reasonable and within the market."  Id. 

Why did the Court reject Spansion's proposed Incentive Plan?  The parties opposing the Plan argued that the Incentive Plan was too generous and was offered to benefit management at the expense of unsecured creditors.  The Debtor, on the other hand, argued that the Incentive Plan allowed the company to attract and retain key employees.  Looking to the evidence presented at the confirmation hearing, the Court noted that peer groups of comparable companies (used as a comparison for the Incentive Plan) was selected by the Debtor's board instead of a compensation expert.  Further, the companies used for the benchmark comparison were those that emerged from chapter 11 bankruptcy between 2003 and 2006.  This comparison, the Court found, did not reflect the dramatic and adverse effects the economy and employee compensation experienced during the last two years.  Opinion at *37. 

Conclusion

Although this post highlights what the Court found was wrong with the Spansion Plan, it is important to note that many of the objections to the Plan were overruled.  For example, the Court found that certain (but not all) of the releases contained within the Plan represented a valid exercise of Spansion's business judgment.  Further, the Spansion Plan included a reserve for administrative claims which the Court viewed as a "reasonable compromise of competing concerns" between the administrative claimants and the Debtor.  Opinion at*50.  The Spansion Opinion, therefore, is helpful in that it shows some of the hurdles a debtor must overcome in order to achieve plan confirmation.  

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Jason Cornell is a bankruptcy attorney with Fox Rothschild LLP in Wilmington, Delaware.  You may contact Jason at 302 427 5512, or jcornell@foxrothschild.com.

Market conditions have not improved for home builders.  Low sales, compounded by volatility in the credit markets, left Orleans with little option other than to file for bankruptcy.  In order to continue its operations while in bankruptcy, Orleans filed a Motion Authorizing the Payment of Certain Critical Vendors on the same day that it filed for bankruptcy.  As stated in the Motion, Orleans owes various vendors and third parties for pre-petition goods and services.  Orleans is concerned that if the pre-pretition claims of its "critical vendors" are not paid immediately, these vendors will no longer provide services and the company will not be able to continue operations.   See Motion at p. 9. 

According to Orleans' bankruptcy petition,  Jeffrey P. Orleans is the company's largest shareholder, owning over 11 million shares, or 59%, of class A stock.  Orleans' largest trade creditors include:

1. 84 Lumber Company ... $1.4 million
2. Robert K. Foster, Inc. ... $1.1 million
3. Sunrise Concrete Company ... $677,234
4. Concrete Solutions of Raleigh, Inc. ... $658,567
5. Archer Exteriors, Inc. ... $616,798

This bankruptcy proceeding is before the Honorable Peter J. Walsh, former Chief Judge of the United States Bankruptcy Court for the District of Delaware.

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Jason Cornell is a bankruptcy attorney who practices in the Wilmington, Delaware office of Fox Rothschild LLP.  You may reach him at 302 427 5512, or jcornell@foxrothschild.com

Legal Standard

The Court began its analysis by looking to section 1102(a)(2) of the Bankruptcy Code which allows for the creation of additional committees within a bankruptcy proceeding.  Under section 1102(a)(2):

On request of a party in interest, the court may order the appointment of additional committees of creditors or of equity security holders if necessary to assure adequate representation of creditors or of equity security holders.  The United States Trustee shall appoint any such committee.  

Citing a decision in the Edison Bros. bankruptcy, the Court noted that the ad hoc committee, as the party seeking the formation of a formal committee, has the burden of proving that an additional committee is needed for adequate representation.  Victor v. Edison Bros. Stores (In re Edison Bros. Stores, Inc.), 1996 WL 534853, *4 (D.Del. Sept. 17, 1996).  The Bankruptcy Code does not define "adequate representation."  Id. at *3.  Instead, the decision whether to appoint an additional committee falls within the discretion of the court based upon the facts of the case.  Opinion at *5, citing In re Dana Corp., 344 B.R. 35, 38 (Bankr.S.D.N.Y. 2006).  Finally, whether to grant a request and appoint an additional committee is considered extraordinary relief that is the exception, not the rule.  Opinion at *6.

Analysis

In deciding whether to grant or deny the motion, the Court examined the evidence offered by the ad hoc committee and the Debtors regarding the valuation of the Debtors' business.  Specifically, the ad hoc committee argued that the Debtors' proposed value excluded several assets that could signficantly increase the company's value.  Debtors, on the other hand, argued that certain assets were appropriately excluded from the valuation analysis because the value of these assets was too speculative.  In the end, the Court found that the equity holders had not met the required burden as the "only thing certain from the record before [the Court] is the uncertainty of the proffered valuations." 

After finding that the equity holders failed to carry their burden and establish they would receive a distribution from the Debtors, the Court turned to whether the equity holders would have adequate representation in the bankruptcy proceeding without the creation of a special committee.  The equity holders argued that the proposed plan and disclosure statement disenfranchised existing shareholders. Further, the equity holders argued that their interests were not represented by the Debtors or the Official Committee of Unsecured Creditors.  However, the Court noted that even if it were to agree with the equity holders and find that the Debtors and Committee did not represent their interest, the Court nevertheless found that the equity holders were "well organized, well represented by counsel, and adequate to the task of representing its interests without 'official' status."  Based on these findings, the Court denied the request for formation of a special committee.

Conclusion

Judge Carey's decision in Spansion illustrates an interesting aspect of bankruptcy practice.  Although the security holders were denied their request for the creation of a formal committee, the Court nevertheless went to great lengthes to examine the security holders' claims against the Debtor.  By this, the Court considered whether Spansion's valuation of its business was too conservative.  Although the Court found that the equity security holders did not make a sufficient record to show Spansion improperly valued the company, the equity holders did receive the full attention of the Court.  This point is important as it illustrates how interested parties, as a group, can have their concerns addressed in a bankruptcy proceeding without the formation of a special committee.

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Jason Cornell is an attorney in Wilmington, Delaware with the law firm Fox Rothschild LLP.  You can contact Jason at 302 427 5512, or jcornell@foxrothschild.com

Besides the recession, Penn Traffic was also hit hard by litigation brought by the SEC in 2007.  The SEC litigation followed a two year investigation of the company's accounting practices.  In addition to the SEC civil litigation, the U.S. Attorney for the Southern District of New York brought criminal charges against certain officers of the company.  These individuals were later terminated by Penn Traffic and a settlement in the civil action was reached almost a year ago.  Even though the SEC litigation is over for the most part,  Penn Traffic notes in its bankruptcy Declaration that "the effects of the significant legal and auditing costs continue to date." 

Penn Traffic's Financials

Penn Traffic has two primary loans - a senior secured credit facility with a balance of $42 million and a supplemental real estate facility with a balance of $10 million.  According to Penn Traffic's bankruptcy petition, the company's ten largest unsecured creditors include:

• ABC Refrigeration ... $405,216
• Coca Cola ... $343,102
• Deli Boy Prov. Co. ... $326,623
• EMC ... $183,846
• G. Weston Bakeries ... $315,213
• Karabus Management ... $437,328
• Local 23 Health Fund ... $518,996
• Nat'l Indus. Portfolio ... $344,183
• New York State Fair ... $333,160
• Stroehmann Bakeries ... $213,105

Objectives in Bankruptcy

The company sought, unsuccessfully, to find additional financing to help it reorganize.  Through an agreement with its secured lenders, Penn Traffic is able to use cash collateral to fund its operations.  However the continued use of cash collateral is contingent on the company seeking a sale under section 363 of the Bankruptcy Code.  Without a sale, Penn Traffic believes it will have no choice but to close all 79 retail stores and 4 warehouses. 

The United States Bankruptcy Court for the District of New Jersey, in a recent decision, spelled out the standard for a sale of a debtor's business outside the ordinary course of business.  In re Congoleum Corp., 2007 WL 1428477 at 2 (Bankr.D. N.J. 2007).  Under Congoleum, a debtor seeking to sell substantial assets must establish a "sound business purpose."  Factors in support of a sound business purpose include:  (i) a sound business reason; (ii) accurate and reasonable notice; (iii) adequate price; and, (iv) good faith.  These factors will be relevant if Penn Traffic succeeds in finding a buyer for its assets. 

This bankruptcy proceeding is before the Honorable Peter J. Walsh, a former Chief Judge of the United States Bankruptcy Court for the District of Delaware.

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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 corporate bankruptcy matter, you may reach Jason at 302 427-5512 or jcornell@foxrothschild.com.

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.