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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.

Spansion sought approval of the settlement agreement pursuant to Fed.R.Bankr.P. 9019. In response to Spansion's settlement motion, an ad hoc consortium of senior secured noteholders (the "Noteholders") filed an objection listing various reasons why the Court should not approve the settlement. After conducting an evidentiary hearing, the Court issued its opinion.

Arguments For and Against the Settlement

Spansion argued that the Court should approve the settlement as it (i) was the product of good faith negotiations; (ii) allowed Spansion to avoid costly and time consuming litigation; (iii) allowed Spansion to avoid naming customers in the patent litigation, potentially harming these relationships; and, (iv) provided Spansion with cash now, instead of waiting years to potentially recover through litigation.

In opposing the settlement, the Noteholders argued that the settlement was both structurally flawed and lacked sufficient information in order for the Noteholders to determine if the settlement amount was fair. Regarding the structural flaws, the Noteholders argued that the settlement provided unbalanced rights to the parties. 

Court's Analysis

The Court began its analysis by noting that under Key3Media Group, settlements under Fed.R.Bankr.P. 9019 are subject to the sound discretion of the Court.  Key3Media Group, Inc., v. Pulver.com, Inc. (In re Key3Media Group, Inc.), 336 B.R. 87, 92 (Bankr. D. Del. 2005).  Further, the role of the bankruptcy court in reviewing a 9019 motion is to determine whether "the compromise is fair, reasonable and in best interests of the estate."  In re TSIC, Inc., 393 B.R. 71, 78 (Bankr. D. Del. 2008).  In order to make its determination,  the Court applied the Third Circuit's analysis in Myers v. Martin (In re Martin), 91 F.3d 389, 393 (3d Cir. 1996).  Under Martin, courts should consider the following factors in deciding whether a settlement is in the best interest of the estate:

1. Probability of success in the underlying litigation;
2. Difficulties in collection;
3. Complexity of the litigation involved, including the expense, inconvenience and delay arising from the litigation; and,
4. Interest of the creditors.

Before applying the factors provided under Martin, the Court noted that it does not have to be convinced that the "settlement is the best possible compromise."  Instead, the Court must decide whether the settlement "is within the reasonable range of litigation possibilities,"  citing In re World Health Alternatives, Inc., 34 B.R. 291, 296 (Bankr. D. Del. 2006).  Further, Debtors carry the burden of persuading the Court that the settlement falls within the reasonable range of settlement possibilities. 

Starting with the first prong of the Martin analysis (probability of success on the merits), the Court noted that its task is to consider the issues presented in the underlying patent litigation and determine whether Spansion's settlement with Samsung "falls below the lowest point in the range of reasonableness."  The Court found that Spansion had not satisfied the "merits prong" of Martin as evidence presented during the hearing showed that Spansion entered the settlement in order to "negotiate a quick settlement,"  instead of considering the settlement by evaluating the merits of the patent cases.

Turning to the second prong under Martin, difficulties in collection, the Court found that Spansion provided no evidence to suggest that Spansion might have trouble collecting a judgment against Samsung. 

The third prong of the Court's Martin analysis looked at the complexity of the litigation involved, including the costs and inconvenience caused by the delay.  Citing Nutraquest, the Court recognized that settlements almost always reduce the "complexity and inconvenience of litigation."  Will v. Northwestern Univ. (In re Nutraquest, Inc.), 434 F.3d 639, 645 (3d Cir. 2006).  What is required, however, is a comparison of the complexity of the underlying litigation to the likelihood of success.  Since the Court found Spansion had not presented evidence sufficient to consider a "likelihood of success," the Court could not determine whether the settlement is better than the expense and inconvenience caused by the continuation of the litigation. 

Finally, the Court considered under Martin the "paramount interest of creditors."  Here, the Court found that the Noteholders "vigorously opposed the settlement agreement."  Further, evidence presented at the evidentiary hearing demonstrated that Spansion did not have sufficient information to determine the reasonableness of the patent litigation settlement.

Conclusion

The Spansion decision provides guidance for what is required for a debtor to obtain approval of a litigation settlement.    Here, the Court found it significant that the settlement agreement contained a "perpetual license to Samsung of the Debtor's future patents."  The Court agreed with the Noteholders that the settlement lacked mutuality between the parties - the agreement appeared to provide more favorable terms to Samsung than Spansion.  The decision does not suggest that settlement agreements must always contain mutual releases between the parties.  Instead, debtors should be prepared to present evidence demonstrating why the settlement is in the best interests of the creditors and that a reasonable determination was made by the debtor that the proposed settlement is preferable to continued litigation expense and delay. 

New Century operated both wholesale and retail mortgage divisions. The wholesale division purchased loans through mortgage brokers and lenders. In the months prior to filing for bankruptcy, New Century's wholesale division operated in 34 locations in 20 states. At the same time, New Century's retail division, which originated loans directly with consumers, was operating out of 262 branch offices employing over 1,700 retail loan officers.

As stated in its Declaration, 86% of New Century's loan origination were subprime loans in the year prior to filing for bankruptcy. Once housing prices begin to decline, New Century's borrowers began to default in greater numbers.

Summary of the Tweeter Bankruptcy

Tweeter's slide into bankruptcy was more gradual than New Century.  According to Tweeter's Declaration in Support of Bankruptcy Petitions,  the company began experiencing operational losses for six years prior to filing for bankruptcy.  Tweeter contends that one of the largest factors to hurt is profitability was the increase in competition from "format stores" such as Walmart and Best Buy. As Tweeter's competitors expanded their footprint in the video products market, competition grew and profit margins declined.  Tweeter's problems worsened when Best Buy and Circuit City both expanded their in-home design and installation programs.

The Preference Actions

With a petition date of April 2, 2007, New Century filed its preference complaints on the eve of the statute of limitations.  Tweeter, on the other hand, has until June 11 before it runs up against the statute of limitations for preference actions (Tweeter filed for bankruptcy on June 11, 2007).  Tweeter, therefore, may file more preference actions in the months ahead.  The New Century preference actions are before the Honorable Kevin J. Carey, Chief Judge of the United States Bankruptcy Court for the District of Delaware.  The Tweeter preference actions are before the Honorable Peter J. Walsh, former Chief Judge of the Delaware Bankruptcy Court.

In prior posts, I have addressed issues relevant to preference litigation.  These posts address topics such as whether new value must remain unpaid to constitute a defense in a preference action.  To read prior posts on this blog regarding preference litigation click here.

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Jason Cornell is a bankruptcy attorney in Fox Rothschild's Financial Services department. If you have any questions regarding this, or any other bankruptcy proceeding discussed on the Delaware Bankruptcy Litigation Blog, you may contact Jason at (302) 427-5512 or jcornell@foxrothschild.com.

Debtors' Financials

According to Monaco's Motion to Use Cash Collateral,  Monaco's prepetition secured debt to Bank of America totals $35.6 million.  Bank of America contends that its working capital loan is secured by a first priority security interest in Monaco's accounts receivable and inventory.  Bank of America further asserts a second priority interest in Monaco's real estate.  Ableco Finance LLC claims that it has a term loan with Debtors for approximately $36.9 million.  Ableco's loan is secured with a second priority interest on Monaco's accounts receivables and inventory, and a first priority security interest on real estate. 

Monaco's top five trade creditors include Custom Chasis Products ($6.8 million), Quality Enterprises USA ($2.7 million),  Lazydays RV Center ($1.1 million), Onan Corp. ($1.0 million) and Hardwoods Specialty Products ($815,000).  Monaco's accounts receivables totaled $6.7 million immediately prior to filing for bankruptcy. 

Events Leading to Bankruptcy

Dealers in the RV industry commonly use "floor plan" financing with third party lenders to finance the dealer's purchase of RVs from manufacturers.  Floor plan loan agreements often require RV manufacturers to agree to repurchase RVs that remain unsold if the dealer defaults on the loan. Monaco has repurchase agreements with many of the floor plan lenders who loan to Monaco's dealers.  As the economy dropped, so too did demand for RVs.  The decline in demand led to greater dealer defaults, in turn requiring Monaco to repurchase inventory from the dealers in default.

Other factors also contributed to Monaco's need to file bankruptcy.  At the same time that consumers were reducing their spending in 2008, fuel costs rose substantially.  By the Fall of 2008, sales for Monaco's Class A diesel motorhomes (its least fuel efficient vehicle), dropped by 43%.  Monaco sells its RVs to dealers, not to consumers.  As a result of the drop in consumer demand, dealer inventories grew.  The overcapacity in the RV market triggered strong price competition, which further reduced revenues.  Finally,  the credit crisis that began in 2008 continues to limit dealer access to floor plan financing.  

Objectives in Bankruptcy

At its peak in 2006, Monaco employed approximately 6,500 employees.  By the time it filed for bankruptcy, it reduced its personnel down to 220.  Those employees that remain will maintain certain production lines while Monaco searches for a buyer.  Prior to bankruptcy, Monaco hired Imperial Capital Corporation to help Monaco sell portions of its business.  Imperial will continue working with Monaco to help find it a buyer during its bankruptcy. 

This bankruptcy proceeding is before the Honorable Kevin J. Carey, Chief Judge of the Delaware Bankruptcy Court.

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If you have any questions regarding this, or any other bankruptcy proceeding discussed on the Delaware Bankruptcy Litigation Blog, please contact Jason Cornell, Esquire at (302) 427-5512. 

 Debtors' Liabilities

The Debtors consist of several entities, however, the two primary entities in this bankruptcy proceeding are Pacific Energy Resources Ltd ("PERL") and Pacific Energy Alaska Operating LLC ("PEAO").  As of the date Debtors filed for bankruptcy,  PERL estimated its liabilities as follows:

• Prepetition Lenders ... $361 million
• Subordinated Noteholders ... $32 million
• Unsecured Lender ... $1 million
• Unsecured Obligations ... $4 million.

PEAO estimated its liabilities as:

• Prepetition Lenders ... $413 million
• Chevron ... $25 million
• Subordinated Noteholders ... $32 million
• Unsecured Obligations ... $9 million

Security for the DIP Facility

The DIP Facility seeks superpriority status pursuant to section 364(c)(1) of the Bankruptcy Code.  Further,  the Facility is secured by a first priority perfected security interest pursuant to sections 364(c)(2) and 364(d) of the Bankruptcy Code.  Section 364(c)(1) and (2) of the Bankruptcy Code authorizes Debtors to obtain credit with "priority over all administrative expenses" and "secured by a lien on property of the estates that is not otherwise subject to a lien."  Before a debtor can obtain postpetition credit, section 364 requires that the debtor demonstrate it was "unable to obtain unsecured credit"  that would be allowed as an administrative expense. In support of their Motion, Debtors cite a decision in the Ames bankruptcy finding that the debtor demonstrated the unavailability of unsecured financing, as required under section 364, where the debtor had sought unsecured financing from several institutional lenders. In re Ames Dept. Stores, 115 B.R. 34, 40(Bankr. S.D.N.Y. 1990).  For a further discussion regarding the adequacy of a debtor's attempt to obtain DIP financing, read my post regarding the Pliant bankruptcy from February 13, 2009.

Conclusion

This bankruptcy proceeding is before the Honorable Kevin J. Carey, Chief Judge of the Delaware Bankruptcy Court.  Judge Carey entered the Debtors Interim DIP Financing Order on March 10, 2009, two days after Debtors filed for bankruptcy.  At the time of this writing, no parties in interest have filed formal objections to the Debtors' Motion to Approve DIP Financing. 

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If you have any questions regarding this, or any other bankruptcy proceeding discussed on the Delaware Bankruptcy Litigation Blog, please contact Jason Cornell, Esquire at (302) 427-5512 or jcornell@foxrothschild.com.

Located in Sunnyvale, California, Spansion employs 1,800 employees in the U.S. and 6,100 employees through foreign subsidiaries. For the first three quarters of 2008, Spansion lists its sales at $1.8 billion. By the time it filed for bankruptcy, Spansion's assets totaled $3.8 billion and its liabilities totaled $2.4 billion. One of Spansion's largest customers, Nokia, accounted for more than 10 percent of its sales in 2007.

Spansion's Financials

According to Spansion's Affidavit, its outstanding debt in the weeks prior to bankruptcy totaled $1.23 billion.  Spansions prepetition secured debt consists primarily of a secured credit facility, senior secured floating rate notes and a line of credit with UBS.  Combined, these three debt facilities have a principal balance of $702 million.  Aside from trade debt, Spansion's unsecured debt totals $457 million (in principal).  Spansion lists its ten largest trade debts as follows:

1. Tel U.S. Holdings ... $49 million
2. TSMC North America ... $13 million
3. KLA - Tencor California ... $11 million
4. Verigy Ltd. ... $10 million
5. Aehr Test Systems ... $9.6 million
6. Form Factor, Inc. ... $8.1 million
7. Saifun Semiconductors ... $7.2 million
8. Applied Materials ... $7.1 million
9. Winbound Electronics ... $5.9 million
10. Toppan Photomasks ... $7.9 million

Events Leading to Bankruptcy

The decline in demand for consumer goods during the Fall of 2008 created a significant reduction in demand for Spansion's goods.  Spansion's situation worsened when credit was tightened in 2008, adversely affecting its liquidity.  Combined, the drop in demand and lack of liquidity interferred with Spansion's ability to fund operations.  Spansion's bankruptcy is before the Honorable Kevin J. Carey, Chief Judge of the Delaware Bankruptcy Court. 

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If you have any questions regarding this, or any other bankruptcy proceeding discussed on the Delaware Bankruptcy Litigation Blog, please contact Jason Cornell, Esquire at (302) 427-5512 or jcornell@foxrothschild.com.

In preparing for bankruptcy, the Debtors created a list of vendors they deemed "critical."  According to Debtors, for a vendor to be categorized as a critical vendor, it had to meet four criteria.  These criteria include supplying "essential" products or services; providing products or services that cannot be replaced;  the vendor indicated that it will not work under similar terms postpetition unless its prepetition invoices are paid; and, the vendor is not contractually obligated to continue working with the Debtors.

Foamex sought relief under the Critical Vendor Motion under section 105(a) of the Bankruptcy Code and pursuant to the "necessity of payment" doctrine.  Under 11 U.S.C. 105(a), bankruptcy courts may invoke equitable powers to "issue any order, process, or judgment that is necessary to carry out the provisions of this title."  To support its use of the necessity of payment doctrine, Foamex cited the Court's decision in In re Just for Feet, Inc., 242 B.R. 821, 826 (D. Del. 1999) (holding that the doctrine requires the debtor to show that payment of the prepetition claims is critical to the debtor's reorganizaton). 

The Lenders' Objection

Foamex's Second Lien Lenders objected to the Critical Vendor Motion, arguing that the necessity of payment doctrine applied to railroad bankruptcies and did not apply to non-railroad bankruptcies.  The lenders cite In re Kmart Corp. in their Objection where the 7th Circuit viewed the necessity of payment doctrine as "just a fancy name for a power to depart from the Code."  359 F.3d 866, 871 (7th Cir. 2004).  By "depart from the Code," the 7th Circuit was recognizing a string of decisions that find that the Bankruptcy Code does not permit a debtor to make distributions to unsecured creditors unless a plan of reorganization has been presented and confirmed.

Despite the Lenders' Objection, the Court ultimately entered an Order approving Debtors' Motion.  The Lenders, however, cannot be totally dissatisfied with the result.  Instead of granting Foamex critical vendor relief up to $29 million, the Court entered an Order granting relief up to $10 million. As is common in bankruptcy, the parties may have reached an agreement on the Motion prior to the hearing.

Second Time in Bankruptcy

Finally, it should be noted that Foamex previously filed for bankruptcy in Delaware in September 2005.  Under its first bankruptcy, Foamex confirmed a plan of reorganization on February 12, 2008.  As stated in Debtors' Critical Vendor Motion, Foamex experienced one of the "best years in the history of the Debtors" in 2007.  Debtors performance was so strong toward the end of its first bankruptcy that they revised the plan of reorganization to include paying unsecured claims in full.  What Debtors were not aware of at the time was that the stronger than anticipated revenue in 2007 was the result of a temporary reduction in supply in 2005 following a strong hurricane season. 

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Should you have any questions regarding this, or any other matters discussed on the Delaware Bankruptcy Litigation Blog, please contact Jason Cornell, Esquire at (302) 427-5512 or jcornell@foxrothschild.com.