On February 13, 2018, Judge Silverstein of the Delaware Bankruptcy Court granted a motion to dismiss the Rent-A-Wreck of America bankruptcy case (Bankr. D. Del. case 17-11592). Judge Silverstein’s opinion is available here (the “Opinion”).

In summarizing her holding, Judge Silverstein provides: These privately-owned debtors are not in financial distress (or at least they have not proven they are), and they seek to use 11 U.S.C. § 365 to redistribute value from a long-time adversary to enrich their ultimate shareholder.  The one entity that may be adversely affected by the Debtors’ bankruptcy filing is the Movant, David Schwartz.  Mr. Schwartz was held by the Maryland District Court, and affirmed by the Fourth Circuit, to be the the holder of an implied-in-fact royalty and fee-free franchise in West Los Angeles.  Opinion at *7.  He argues that the Debtors filed bankruptcy for the sole purpose of rejecting his franchise, and are not filed in good faith, but are instead a continuation of the Maryland District Court litigation.  Opinion at *12

The Debtors argued that they filed for bankruptcy protection to maximize the value of the Rent-A-Wreck trademark, to reject burdensome franchise agreements, and to relieve Debtors’ balance sheet of significant debt, all of which Debtors posit constitute valid reorganizational purposes. Opinion at *12.

Judge Silverstein began her analysis of this case by reviewing the inquiry of the Debtors’ good faith as directed by  precedential holdings of the Third Circuit.  Opinion at *14.  The Third Circuit considers two primary factors to determine good faith – first, whether the petition serves a valid bankruptcy purpose, second, whether the petition was filed to gain a tactical advantage.  Id.  The main precedential opinion cited by Judge Silverstein is In re Integrated Telecom Express, Inc., 384 F.3d 108 (3d Cir. 2004).

According to the Opinion, good faith is a predicate to a debtor’s ability to use provisions of the Bankruptcy Code, and financial distress is a part of if not itself a predicate to—a good faith analysis.  Opinion at *15.  Judge Silverstein continues: The ability to use the redistributive
provisions of the Bankruptcy Code assumes the existence of a valid bankruptcy, which, in turn, assumes a debtor in financial distress.  Id.  In this case, the Debtors never represented that they were insolvent, and Judge Silverstein, accordingly, determined that they were solvent.  Opinion at *18.  Neither did the Debtors provide evidence indicating that they were unable to pay their debts as they came due.  Opinion at *19.  Judge Silverstein determined that, in sum, the lack of credible facts demonstrating financial distress supports a finding that these cases were not filed in good faith.  Opinion at *26.

Pursuant to the Opinion, Judge Silverstein understood the Debtors’ argument that their filing was in good faith as follows: the rejection of the Schwartz franchise agreement maximizes Debtors’ assets thus permitting them to stay in business, satisfying both prongs of the bankruptcy purpose.  Opinion at *28.  Judge Silverstein disagreed, quoting Integrated Telecom:

To be filed in good faith, a petition must do more than merely invoke some distributional mechanism in the Bankruptcy Code. It must seek to create or preserve some value that would otherwise be lost—not merely distributed to a different stakeholder—outside of bankruptcy.

Opinion at *28 (quoting Integrated Telecom, 384 F.3d at 128-29) (emphasis in Opinion).  Judge Silverstein concludes my opining that the Debtors bankruptcy filing was made for the purpose of redistributing the value of the Rent-A-Wreck trademark in the Los Angeles territory from Mr. Schwartz to Bundy.  Opinion at *29.   Accordingly, the primary, if not sole, beneficiaries of that value would be the Debtors’ equity holders, not its creditors.  Judge Silverstein states that she has “no doubt these petitions were just another chapter in the attempt to terminate Mr. Schwartz’s franchise and obtain the benefits for JJFMS.”  Opinion at *36.

Judge Silverstein provides in the Opinion, that a financially distressed debtor’s recognition of the outcome of litigation and/or a desire to avoid future litigation may serve as a legitimate basis for the filing of a bankruptcy case. Opinion at *36.  I note, however, that the thread running throughout the Opinion is the requirement that a debtor be financially distressed in order to take advantage of the relief provided by the Bankruptcy Code.  Financial distress is a broad term, that can be applied to entities ranging from those suffering a liquidity crisis with substantial equity – to those suffering from over-leverage or long-term non-profitability.  In these situations, and countless others, the Bankruptcy Code can provide relief.  It is important, however, to ensure that your company can satisfy the Court’s scrutiny of whether a petition was filed in good faith – recognizing that the burden of proof is on the debtor.

John Bird practices with the law firm Fox Rothschild LLP and is resident in Portland, Oregon. You can reach him at 302-622-4263, or jbird@foxrothschild.com.

On January 31, 2018, Hancock Fabrics Inc., the post-effective date debtor, filed approximately 68 complaints seeking the avoidance and recovery of allegedly preferential and/or fraudulent transfers under Sections 547, 548 and 550 of the Bankruptcy Code. The Debtors filed voluntary petitions for bankruptcy in the U.S. Bankruptcy Court for the District of Delaware on February 2, 2016 under Chapter 11 of the Bankruptcy Code.  On June 20, 2017, the Court entered an order confirming the Debtors’ Second Amended Joint Chapter 11 Plan of Liquidation. The various avoidance actions are pending before the Honorable Brendan Shannon.  For preference defendants looking for an analysis of defenses that can be asserted in response to a preference complaint, below are several articles on this topic:

Preference Payments: Brief Analysis of Preference Actions and Common Defenses

Minimizing Preference Exposure: Require Prepayment for Goods or Services

Minimizing Preference Exposure (Part II) – Contemporaneous Exchanges

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

On January 22, 2018, in an adversary proceeding arising within the Haggen bankruptcy (Adv. No. 16-51204), Judge Gross of the Delaware Bankruptcy Court issued a ruling against the Plaintiff, denying the relief requested in the complaint and dismissing the adversary proceeding. Judge Gross’s opinion is available here (the “Opinion”).

The Committee filed an adversary proceeding with a 78 count, 145 page Complaint making numerous allegations including, but not limited to, fraudulent transfers, breach of fiduciary duties, and unjust enrichment.  The Defendants’ answer spanned 184 pages, denying the numerous allegations and laying out the groundwork for the intense legal battle that followed.  Accordingly, it came as no surprise that the trial lasted five days and Judge Gross’s Opinion was 162 pages.

This Opinion follows on the heels of motions for summary judgment, which were previously discussed in this blog post:  In Fact Intensive Issues, You Need a Trial to Provide the Court With the Facts.

As one could presume based on Judge Gross’s affable nature, both in the courtroom, in the public sphere, and in his rulings, Judge Gross has crafted this Opinion in a manner that clearly guides the reader through each issue and includes an easily understood summary.  Judge Gross held that the Defendants were not so cavalier in planning and effecting the Project that they were grossly negligent nor that there was anything inherently wrong with the OpCo-PropCo structure.

The Project failed but not because the Defendants did not care if it succeeded. Moreover, it is not uncommon for parties who are planning a transaction to make certain that they are protected in the event the transaction fails. Such protection from adverse results is one of the reasons for forming a corporation or other entity – to limit personal liability.

It is unnerving that the Project failed in a matter of months and certainly the Court had questions about how it happened. It turns out that the people in charge, the Individual Defendants, to some degree were not prepared. They were not, however, grossly negligent and they certainly meant for Haggen, Holdings and the OpCo to succeed. The Committee made a strong case but, at the end of the day failed to establish gross negligence or self-dealing or the existence of any fraudulent transfers. The Committee did establish that the leases between Spirit and GIG, and the OpCo’s, were above the market rate, but there is no liability. The Committee failed however, to establish the remaining counts of the Complaint.

Opinion at *3.  Judge Gross then cites to the Delaware Chancery Court for the proposition that “to allege that a corporation has suffered a loss as a result of a lawful transaction, within the corporation’s powers, authorized by a corporate fiduciary acting in a good faith pursuit of corporate purposes, does not state a claim for relief against that fiduciary no matter how foolish the investment may appear in retrospect.”  Opinion at *4 (quoting Gagliardi v. TriFoods Int’l, Inc., 683 A. 2d 1049, 1052 (Del. Ch. 1996)).

This case arose from a buyout that was structured with separate entities having separate roles.  The property owning entities have been successful – real estate is, after all, booming.  The operating entities, however, have struggled like a large number of other retailers.  Retail bankruptcy cases are at an all-time high and rents are higher than ever.  As Judge Gross recognized in the Opinion, the corporate structure is meant to provide down-side protection to equity holders.  In this instance (pending any possible appeals), the corporate form appears to have operated precisely as intended.

John Bird practices with the law firm Fox Rothschild LLP and is resident in Portland, Oregon. You can reach him at 302-622-4263, or jbird@foxrothschild.com.

 

 

On her The Bottom Line 11 blog, Fox partner Mette Kurth examined new bankruptcy venue reform legislation recently unveiled in the U.S. Congress:

U.S. Capitol Building, Washington, D.C.Earlier today, Senators John Cornyn (R-TX) and Elizabeth Warren (D-MA) introduced the Bankruptcy Venue Reform Act of 2017The bill would require companies to seek bankruptcy protection where they are physically headquartered. And it would simultaneously prohibit them from filing where they are incorporated or where an affiliate has a pending case. The end result? The bill would effectively limit access to popular bankruptcy courts in New York and Delaware. If passed, this would represent a seismic shift for corporate bankruptcies.

Sens. Cornyn and Warren said in a joint statement that the bill is meant to strengthen the integrity of the bankruptcy system and build public confidence by preventing companies from “shopping” for favorable courts. The bill is also intended to allow employees at bankrupt companies, small business creditors, and others to participate in cases that will have tremendous impacts on their lives.

To read Mette’s viewpoint on the new legislation and its impact, please visit her blog.

On December 29, 2017, Life Settlement Absolute Return I, LLC (“LSAR”), along with Senior LS Holdings, LLC (“Senior LS”; collectively with LSAR, the “Debtors”), filed petitions for relief under Chapter 11 in the Bankruptcy Court for the District of Delaware (Case Nos. 17-13030 and 17-13031).

According to the Declaration in Support of the First Day Motions of Robert J. Davey, III (“Davey Declaration”), LSAR was formed as a special purpose vehicle to invest in life insurance policies in the life settlement market. LSAR has comprehensive agreements with third-parties for the provision of management, administrative and operational services.  Senior LR operates as a holding company for the policies.

According to the Davey Declaration, the Debtors have been unable to pay their existing debt, primarily because many insureds have outlived their actuarial life expectancy, prolonging LSAR’s receipt of cash from the death benefits of the policies.  Thus, it became financially difficult for LSAR to continue servicing premium payments on the policies.

The Debtors have have filed a number of first day motions, including a cash collateral motion, a joint administration motion, and a motion to maintain the Debtors’ bank accounts.  As of the date of this post, the first day hearing has not yet been noticed.  The cases have been assigned to the Honorable Mary F. Walrath.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

On her The Bottom Line 11 blog, Fox partner Mette Kurth notes an expected imminent push in the U.S. Congress for bankruptcy venue reform:

U.S. Capitol Building, Washington, D.C.I have barely unpacked my suitcases, and yesterday the Commercial Law League of America (CLLA) announced that a bankruptcy venue reform bill will be proposed this week in the U.S. Senate. The bill will to seek to change the venue rules for filing Chapter 11 business cases. If you want to view the CLAA’s press release, it is available here. (The CLLA previously supported S.314 (109th Congress 2005-2006) and H.R.2533 (112th Congress 2011-2012), which were not enacted.)

To read Mette’s full discussion of the debate over the reforms, which are set to be proposed the week of December 18, 2017, please visit her blog.

On her The Bottom Line 11 blog, Fox partner Mette Kurth examined a recent U.S. Court of Appeals for the Second Circuit decision in In re MPM Silicones (the Momentive case). The court followed the lead of the Sixth Circuit in establishing a two-step approach to setting the cramdown interest rate on debtor payments for secured claims:

Court Pillars
Copyright: bbourdages / 123RF Stock Photo

A simple proposition—that secured lenders are entitled to receive payments with a present value at least equal to the amount of their claim—has proven surprisingly difficult to apply as courts have pondered whether to follow a “formula approach” or a “market approach” to establish an appropriate “cramdown” interest rate. (A primer is available here if you are new to the debate.)

Secured lenders have scored a significant win in the recent Second Circuit decision in the Momentive case, In re MPM Silicones. Siding with the Sixth Circuit, the Second Circuit has decided that the prevailing market rate for comparable debt should be used—if there is an efficient market for such debt—and that the formula approach should be used only if no efficient market exists.

To read Mette’s full rundown of the decision and its impact, please visit her blog. Mette also provides background on cramdown interest rates in a separate post.

In a 32 page opinion entered December 5, 2017 Judge Gross of the Delaware Bankruptcy Court ruled on cross motions for summary judgment concerning an avoidance action in the Simplexity bankruptcy. Judge Gross’s opinion is available here (the “Opinion”).  This Opinion arises from a complaint brought by Charles A. Stanziale, Jr., as the Chapter 7 Trustee of Simplexity, LLC against the Sprint Corporation alleging that payments made by the debtor to Sprint of $3,842,951.86 were avoidable transfers.  Two issues were the subject of the joint motions for summary judgment,  (1) did the Trustee satisfy his burden of demonstrating that Sprint received more by the Transfers than it was entitled to under Chapter 7, and (2) is Sprint entitled to a new value defense for two transfers (of $505,151.53 and $125,000.00 respectively) made to Simplexity?

First, the analysis of Sprint’s recovery.  The primary issue of contention is whether the Trustee’s use of the “Add-Back” method was appropriate.

The Trustee performed a liquidation analysis using the add-back of analyzing a defendant’s position on the petition date given a hypothetical liquidating by 1) accounting for the debt that was still owed by the Debtors to the defendant on the petition date; 2) adding back in the transfers paid in the preference period to the outstanding debt (i.e., complying with Section 547(b)(5)(B)’s requirement of analyzing the situation as if ‘the transfer had not been made’); and 3) comparing that debt to the collateral [as] of petition date.

Opinion at *22.  Judge Gross held that the Trustee’s methods were appropriate, and that it was able to trace what Sprint’s recovery would have been in the chapter 7 bankruptcy both with, and without these payments as a result of Sprint’s liens.  Accordingly, he granted the Trustee’s summary judgment motion on this point.  He did, however, differentiate a few cases, so if you are in a similar situation, please read the entirety of this portion of the Opinion.  It’s a quality lesson in distinguishing case law.

Second, Sprint’s New Value.

In this portion of the Opinion, Judge Gross looks to the spirit of the new value defense provided by 11 U.S.C. 547, describing “the overarching principle of Section 547(c)(4)” as the provision by a creditor of “a beacon of light in a dark time.”  Opinion at *29.  Sprint made a mid-month payment (the $505,151.53 payment), which was not contractually required.  The Court determined that because this payment was not contractually required, it constituted new value, and was not a payment made on account of amounts due and owing by Sprint.  Opinion at *28.

The second allegedly new value payment, however, was related to a “Loyalty Trial Program”.  Opinion at *30.  Since neither party provided any evidence as to the Loyalty Trial Program and whether Simplexity was entitled to the $125,000 payment, Judge Gross denied both motions for summary judgment as to this payment.

This is a compelling Opinion if you are on either side of a new value defense.  This Opinion analyzes both the receipt of more than a creditor is entitled to under chapter 7, and how new value is treated in a situation when a creditor is also obligated to make a payment to the debtor.

John Bird practices with the law firm Fox Rothschild LLP and is resident in Portland, Oregon. You can reach John at 302-622-4263, or jbird@foxrothschild.com.

On November 17, 2017, Real Industry, Inc., along with its subsidiaries and affiliates (collectively the “Debtors” or “Real Industry”), filed a petition for relief under Chapter 11 in the Bankruptcy Court for the District of Delaware (Case No. 17-12464).

According to the Declaration in Support of First Day Motions of Michael J. Hobey, liquidity issues and certain singular negative events have led to Real Industry’s bankruptcy filing. The Debtors operate an aluminum recycling and alloy production company based in Beachwood, Ohio.

Contemporaneously, Real Alloy Holding, Inc. and its U.S. subsidiaries filed petitions for voluntary Chapter 11 reorganization in the U.S. Bankruptcy Court for the District of Delaware.  However, Real Alloy’s operations in Germany, United Kingdom, Norway, Canada and Mexico and its Goodyear, Ariz. joint venture are not included in the filings.

The First Day Hearing is scheduled for Monday, November 20th at 1:00 PM at US Bankruptcy Court, 824 Market St., 5th Fl., Courtroom #5, Wilmington, Delaware.  The Debtors have have filed a number of First Day Motions, including, but not limited to, the following:

  • Motion to Pay Employee Wages and Maintain and Continue Certain Compensation and Benefit Programs Postpetition;
  • Motion for Continuation of Utility Service and Approval of Adequate Assurance of Payment to Utility Company Under Section 366(b);
  • Motion to Pay Critical Trade Vendor Claims and Authorizing the Debtors to Pay Certain Prepetition Claims of Shippers, Warehousemen, and Materialmen; and Authorizing Banks to Honor and Process Checks and Electronic Transfer Requests Related Thereto; and
  • Motion to Authorize Debtors to (A) Continue Performing Under Prepetition Hedging and Trading Arrangements and Honor Obligations Related Thereto, and (B) Enter Into and Perform Under New Postpetition Hedging Arrangements.

The cases have been assigned to the Honorable Kevin J. Carey.  The proposed claims and noticing agent is Prime Clerk LLC.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In a short opinion entered November 14, 2017 Judge Gross of the Delaware Bankruptcy Court denied a motion of an interested party to “Attend and Participate in the Rule 2004 Examinations to be Conducted by the Trustee”. Judge Gross’s opinion is available here (the “Opinion”).

This is a very short Opinion and resolves a very straight-forward issue.  Can a party in separate litigation take advantage of Bankruptcy Rule 2004 to obtain discovery from the opposing party?

The answer: No.

Citing multiple cases, Judge Gross explains that the “pending proceeding rule” provides that once an adversary proceeding or contested matter has been commenced, discovery must proceed under the federal discovery rules.  The cited opinions were: In re SunEdison, Inc., 572 B.R. 482 (Bankr. S.D.N.Y. 2017);  In re Wash. Mut., Inc., 408 B.R. 45 (Bankr. D. Del. 2009); In re Enron Corp., 281 B.R. 836 (Bankr. S.D.N.Y. 2002); 2435 Plainsfield Ave. v. Township of Scotch Plains (In re 2435 Plainsfield Ave.), 223 B.R. 440 (Bankr. D.N.J. 1998); In re Coffee Cupboard, Inc., 128 B.R. 509 (Bankr. E.D.N.Y. 1991).

As discussed in a previous post on this blog, 2004 discovery is most akin to fishing expeditions meant to determine whether or not litigation should be commenced.  You can read that post here: What are the Scope and Limitations of a Rule 2004 Examination?

John Bird practices with the law firm Fox Rothschild LLP and is resident in Portland, Oregon. You can reach John at 302-622-4263, or jbird@foxrothschild.com.