Judge Kevin J. Carey, Chief Judge of the Delaware Bankruptcy Court, issued a decision recently in the S-Tran Holdings bankruptcy that addresses whether letters of credit constitute property of the bankruptcy estate.  The Court’s decision in S-Tran Holdings is worth review as letters of credit are a common part of a debtor’s pre and post-petition financing.  Recent decisions hold that certain components of letters of credit (such as the proceeds drawn from the letter of credit) are estate property, while other components (like the collateral pledged for the letter of credit) are not estate property.  S-Tran explains why.  (A copy of the decision in S-Tran is available here).


The debtor in S-Tran sued its insurer in an effort to recover the proceeds from a letter of credit and a cash deposit, both held by the insurer.  In order for the insurer to provide coverage to S-Tran, S-Tran had to provide a $477,000 cash deposit and letters of credit totaling $3.5 million.  A week prior to S-Tran’s bankruptcy filing, the debtor’s insurer drew on portions of the letter of credit to pay third parties and placed the remaining proceeds from the letter of credit in a loss reserve account.  After filing for bankruptcy, S-Tran demanded the insurer return the proceeds from the letters of credit, however, the insurer refused.

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.).


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.


In recent months, bankruptcy auctions went forward in two different bankruptcy proceedings that illustrate the extent to which auctions can vary both procedurally and substantively. One auction involved the sale of a single asset and lasted less than an hour, while the second auction involved the sale of the debtor’s entire business and lasted over the course of several days.  This post is intended to provide a brief “compare and contrast” of these two auctions in an effort to provide insight into a process that is a common component of corporate bankruptcies.

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.


On June 25th, the Debtors in the SemCrude bankruptcy present their Motion Approving Debtors’ Disclosure Statement (the “Motion”).  Debtors’ Motion provides a good opportunity to review the standards by which bankruptcy courts often measure the content of a debtor’s disclosure statement.  The following provides a summary of some of the frequently cited cases and Bankruptcy Code provisions governing this fundamental component of the bankruptcy reorganization process.

The Code Provisions

A disclosure statement must contain adequate information for creditors and shareholders to make an informed judgment about a plan of reorganization. See In re Scioto Valley Mortgage Co., 88 B.R. 168, 170 (Bankr. S.D. Oh. 1988). Section 1125(b) of the Bankruptcy Code provides the threshold level of information that must be included in a disclosure statement:

An acceptance or rejection of the plan may not be solicited after the commencement of the case under this title from a holder of claim or interest with respect to such solicitation, unless, at the time of or before such solicitation, there is transmitted to such holder the plan or a summary of the plan, and a written disclosure statement approved, after notice and a hearing, by the court as containing adequate information.
11 U.S.C. § 1125(b).  (Emphasis added).

“Adequate information” is defined under 11 U.S.C. Sec. 1125(a)(1) as “information of a kind, and in sufficient detail, as far is reasonably practicable in light of the nature and history of the debtor and the condition of the debtor’s books and records, that would enable a hypothetical reasonable investor typical of holders of claims or interest of the relevant class to make an informed judgment about the plan, but adequate information need not include such information about any other possible or proposed plan.”

Courts have denied approval of a disclosure statement where the allegations contained in the statement were “unsupported by factual information so that voting parties were unable to independently evaluate the merits of the plan.” In re Copy Crafters Quickprint, Inc., 92 B.R. 973, 980 (Bankr. N. D. NY 1988) (internal citations omitted).  Congress intended the disclosure statement to be the primary source of information that will allow creditors and shareholders to make informed decisions regarding the proposed plan.  In re Scioto, supra., citing In re Egan, 33 B.R. 672, 675 (Bankr. N.D. Ill 1983).

Factors Considered by the Court

Bankruptcy courts exercise broad discretion when deciding whether to approve or reject a disclosure statement. In making a determination, courts often look at whether the disclosure statement contains the following types of information:

  1. the circumstances that gave rise to the filing of the bankruptcy petition;
  2. a discussion of assets available and their value;
  3. a summary of what the debtor anticipates to do going forward;
  4. where the information used in the disclosure statement came from;
  5. a disclaimer stating that no statements or information regarding the debtor, its assets or securities are authorized, other than those included in the disclosure statement;
  6. the debtor’s condition during its bankruptcy proceeding;
  7. claim information;
  8. an analysis showing what creditors would receive from the debtor were it liquidated under chapter 7;
  9. the accounting and valuation methods used in the disclosure statement;
  10. information regarding the debtor’s management going forward;
  11. a summary of the plan of liquidation or reorganization;
  12. a summary of the administrative expenses, including bankruptcy professional fees;
  13. a review of the debtor’s accounts receivables;
  14. financial information necessary to allow a creditor to decide whether to approve or reject the plan;
  15. information regarding the risks being taken by the creditors;
  16. the amount expected for recovery through avoidance actions;
  17. a discussion of nonbankruptcy litigation;
  18. tax consequences of the plan; and,
  19. the debtor’s relationship with any affiliates.

See In re Scioto Valley Mortgage Co. supra., 88 B.R. at 170-71.


The Producers’ Committee in SemCrude filed a Preliminary Objection to the Debtors’ Disclosure Statement claiming the Disclosure Statement failed to provide “adequate information” regarding Debtors’ assets and liabilities and the feasibility of the Debtors’ plan, among others.  When a party objects to a disclosure statement, there are usually one of two outcomes:  a consensual resolution is reached by the debtor and objecting party; or the Court decides the matter.  If the Court has to rule on the Producers’ Objection, it will be interesting to see the level of disclosure that is required of the SemCrude Debtors in light of the facts of this case.


On May 1, 2009, Magna Entertainment (“Magna”) filed a motion in the United States Bankruptcy Court for the District of Delaware whereby it sought authority to schedule an auction, receive approval of auction bid procedures and proceed with the sale of assets (the “Sale Motion“).  I have previously written about bankruptcy sale motions on this blog,  however, I wanted to devote this post to the auction procedures that are often used in bankruptcy proceedings.  Specifically, this post is intended to address questions that arise when a chapter 11 debtor seeks to auction of assets.  Among them, how do debtors go about auctioning assets while in bankruptcy, how long does the auction process take, and finally, what are common requirements imposed on parties wishing to bid on a debtor’s assets?  Recognizing that no two bankruptcies are the same, this post will look at the auction procedures proposed in Magna in an effort to shed light on the bankruptcy auction process in general.

Procedural History

The Sale Motion Magna filed on May 1st was not its first sale motion.  Magna filed its first and second sale motions on March 10 and March 17, 2009 (the “Original Sale Motions”).  Under the Original Sale Motions, Magna sought to sell substantially all of its assets under an auction process that included the establishment of bidding procedures for interested parties.  As is common in bankruptcy, various parties objected to the Original Sale Motions, which in turn resulted in Magna filing an amended Sale Motion addressing some of the concerns raised by the objecting parties.  This post focuses on the auction procedures within the amended Sale Motion.

The Objectives of an Auction

The reason a debtor seeks to auction off assets is relatively simple – to generate cash for the bankruptcy estate.  According to Magna’s Sale Motion, “the sale of [Magna’s] assets will generate the maximum value for the Debtors’ estates.”  To insure debtors receive “maximum value” from the sale of the assets, parties in interest in a bankruptcy proceeding often scrutinize an auction to insure the process is open and fair.  Doing so increases the likelihood that the auction will result in a sale of assets at market value.  If the debtor’s  assets are not properly marketed to potential buyers, the resulting sale may be for less than full market value.

In order to have a competitive auction, debtors will often hire a financial adviser to help market the assets.  In the Magna bankruptcy, both the Debtors and the creditors’ committee hired financial advisers to create a process to solicit and review bids from potential purchasers.

The Auction Process

Under the Sale Motion, parties wishing to participate in the Magna bankruptcy auction must submit an “expression of interest” to Magna declaring a party’s desire to bid on assets.  Specifically, parties wishing to bid on Magna’s assets must sign  a confidentiality agreement regarding the information that will be made available to the bidder.  Next, bidders must designate which assets they wish to bid on and assign a range of value to these assets.  Finally, potential bidders must demonstrate to the debtor’s satisfaction that the bidder has the financial means by which to complete the purchase of assets.

After submitting an expression of interest as outlined above, the Magna Sale Motion requires bidders to submit bids to Magna on or before 5:00 EST, on July 31, 2009.  Under the Sale Motion, Magna provides potential bidders with approximately 90 days from the time it filed the amended Sale Motion to submit full or partial bids on its assets.

Magna’s Sale Motion requires bidders to submit “definitive bids.”  To constitute a definitive bid, bidders must submit a signed copy of a form agreement provided by Magna representing an “irrevocable and binding contract.”  To qualify as a “definitive bid,”  Magna requires that bidders satisfy the following criteria:

  • Bids cannot be contingent on the bidder receiving financing, nor may bids be contingent on a bidder receiving approval from its board of directors or a regulatory body;
  • Bidders must identify the entity participating in the auction;
  • Bidders must state that the offer submitted is irrevocable until closing of the sale of assets;
  • Bidders must state that they do not request any transaction or break-up fee, expense reimbursement, etc.;
  • Bids must be accompanied by a 10% deposit of the definitive bid amount, delivered by certified or wired funds which funds will be available to fund the purchase price in the event the bidder prevails at the auction;
  • Bidders must provide financial information about the bidder such as the latest unaudited financial statement of the bidder.  Magna reserves the right to waive this requirement on a case-by-case basis.

Once bids are submitted, the debtor will conduct an auction.  Auctions are often held in the office of the debtor’s attorney.  Under the Magna Sale Motion, the debtors propose scheduling the auction on September 8, 2009 – 4 months after Magna filed its amended Sale Motion.

On May 11th, the Court entered the Order approving the Sale Motion.  It remains to be seen whether Magna will have the competitive auction its procedures were intended to create.


Section 341 of the Bankruptcy Code requires the United States Trustee to “convene and preside at a meeting of creditors.”  Section 341(a) of the Code requires the trustee to convene what is commonly referred to as a “341 meeting” or “meeting of creditors” within a “reasonable time” after a debtor files for bankruptcy.  Bankruptcy Rule 2003(a) requires the Trustee to call a meeting of creditors “no fewer than 20 and no more than 40 days” after the commencement of a bankruptcy proceeding.

The meeting of creditors is a unique part of bankruptcy proceedings.  Clients and co-counsel often want to know what information is made available, and what procedures are followed, during a typical meeting of creditors.  This post will take a look at the recent meeting of creditors in the Magna Entertainment bankruptcy.  By doing so, the goal is to provide creditors and their counsel with an idea of what to expect in future meetings of creditors.

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.


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.


On March 10, 2009, the Honorable Christopher S. Sontchi of the United States Bankruptcy Court for the District of Delaware issued a decision addressing the standard for preliminary injunctive relief in bankruptcy.  This post will look at the substantive and procedural issues considered by the Court in Broadstripe LLC v. National Cable Television Cooperative (In re Broadstripe). Specifically, when is injunctive relief appropriate in a bankruptcy proceeding and how does a party go about seeking injunctive relief under the Federal Rules of Bankruptcy Procedure?


Broadstripe filed for bankruptcy in Delaware on January 2, 2009.  In July of 2000, eight years prior to filing for bankruptcy, Broadstripe joined the National Cable Television Cooperative ("NCTC") whereby NCTC agreed to negotiate master programming agreements for Broadstripe.  Under the programming agreements,  Broadstripe paid NCTC the licensing fees for programming services and NCTC distributed the funds paid by Broadstripe to various programmers (such as Fox, Disney, etc.).  In the months leading up to bankruptcy, Broadstripe failed to pay NCTC over $3.4 million in licensing fees.  However, after filing for bankruptcy Broadstripe paid NCTC all licensing fees incurred from the petition date forward. 

Continue Reading Decision in Broadstripe Bankruptcy Looks At Standard for Preliminary Injunctive Relief


The Fairchild Corporation (“Fairchild” or the “Debtor”), filed for bankruptcy in Delaware on March 18, 2009.  Fairchild’s bankruptcy proceeding is before the Honorable Christopher S. Sontchi of the United States Bankruptcy Court for the District of Delaware.  According to its press release, Fairchild operates in three markets:  aerospace, real estate and motor cycle apparel.  In the aerospace industry, Fairchild distributes parts and equipment to companies servicing aircraft.  Fairchild’s business also includes managing and developing commercial real estate.  Finally,  with its apparel business, Fairchild designs and produces motorcycle apparel for companies such as Harley Davidson and PoloExpress.  (Read Fairchild’s Affidavit in Support of Bankruptcy Motions here.)

The DIP Financing Motion and Relief From the Automatic Stay

One of Fairchild’s “first day” motions seeks debtor-in-possession (“DIP”) financing, refinancing of prepetition debt and modification of  the automatic stay (the “DIP Motion“).  As stated in the DIP Motion,  Fairchild’s prepetition debt totals $19 million and Fairchild seeks to refinance its debt with a postpetition revolving credit facility up to $23 million (the “DIP Facility”).  Under the DIP Facility, PNC, as postpetition lender, would receive a “priming lien” that is senior or equal to previously encumbered property.  Fairchild seeks the priming lien for the DIP Facility pursuant to 11 U.S.C. 364(d)(1)(authorizing a bankruptcy court to approve DIP financing secured by an equal or superior lien on property of the estate already subject to a lien, provided the holder of the primed lien receives adequate protection).

Pursuant to paragraph 65 of the DIP Motion, Fairchild proposes that the automatic stay under 11 U.S.C. 362 be vacated to permit the DIP lenders to perform “any acts necessary to implement” the DIP Facility.  In addition, Fairchild seeks to lift the automatic stay for the lenders “to the extent necessary to exercise, upon the occurrence and during the continuation of any event of default … and to take various actions without further order of or application to the Court.”  Although the DIP Motion does not contain citations for granting relief from the automatic stay, it notes that “[s]tay modification provisions of this sort are ordinary and usual features of debtor in possession financing.”  This blog post will look at the standard often applied in Delaware for parties seeking relief from the automatic stay.

Scope of the Automatic Stay

Section 362(a)(3) of the Bankruptcy Code defines the scope of the automatic stay.  Under this section, the automatic stay bars any “act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.”  In order to have the stay “lifted,”  section 362(d) authorizes a bankruptcy court to “grant relief from the stay provided
under subsection (a) of this section, such as by terminating, annulling, modifying or conditioning such stay …(1.) for cause, including the lack of adequate protection of an interest in property of such party in interest.”

In order to trigger the automatic stay, there must be an act against either the debtor or against property of the debtor or of the estate. The automatic stay does not stay actions taken against non-debtor third parties. The Third Circuit has recognized that although the automatic stay has a broad scope,  the clear language under 362(a) applies only against a debtor.  See McCartney v. Integra Nat’l Bank North, 106 F.3d 506, 509 (3d Cir. 1997).  As a consequence “it is universally acknowledged that an automatic stay of proceedings accorded by § 362 may not be invoked by entities such as sureties, guarantors, co-obligors, or others with a similar legal or factual nexus to the … debtor.”  Id.

Relief from Stay

Under section 362(d)(1) of the Bankruptcy Code, the bankruptcy court “shall” lift the automatic stay for “cause.”  If a creditor seeking relief from the automatic stay makes a prima facie case of “cause” for lifting the stay, the burden going forward shifts to the debtor pursuant to Bankruptcy Code § 362(g). See In re 234-6 West 22nd St. Corp., 214 B.R. 751, 756 (Bankr.S.D.N.Y. 1997).

The Bankruptcy Code does not define “cause.” Instead, whether cause exists to lift the automatic stay should be determined on a case by case basis. See Izzarelli v. Rexene Prod. Co. (In re Rexene Prod. Co.), 141 B.R. 574, 576 (Bankr.D.Del. 1992). See also, In re Texas State Optical, Inc., 188 B.R. 552, 556 (Bankr. E.D.Tex. 1995) (finding that “cause” for modification of the automatic stay is “an intentionally broad and flexible concept that permits … [a] [b]ankruptcy [c]ourt, as a court of equity, to respond to inherently fact-sensitive situations.”) Courts determine what constitutes “cause” based on the totality of the circumstances in each particular case. Baldino v. Wilson (In re Wilson), 116 F.3d 87, 90 (3d Cir. 1997).

In re Rexene provides the “balancing test” to determine whether cause exists to lift the automatic stay. 141 B.R. at 576. Under Rexene, the balancing test looks at three factors to decide whether to lift the automatic stay, including: (a.) whether prejudice will be caused to the estate or the debtor;
(b.) whether hardship to the movant from continuing the stay outweighs any hardship to the debtor; and (c.) whether the movant has a reasonable probability of prevailing on the merits of the suit. Id.


The relief from stay sought for the DIP lenders in the Fairchild DIP Motion serves as one example of the importance of the automatic stay.  Through the DIP Motion, Fairchild seeks to preemptively lift the automatic stay so its lenders can exercise their rights in the event of a default.  Without receiving such blanket protection, lenders may be unwilling to lend to a debtor in possession.  Regardless, the automatic stay is a fundamental protection provided to debtors.  It is always helpful to understand the scope of the stay, as well as the parameters applied when a party seeks relief from the automatic stay.


Bankruptcy lawyers are sometimes asked how a business or individual can be required to defend a lawsuit in Delaware.  Typically, this issue arises when a debtor commences an adversary action, such as filing a preference complaint, and sues a defendant who has no ties to Delaware.  “How can they do this?” is a common question.  Judge Walrath recently issued a decision in the Uni-Marts bankruptcy that addresses this question – the scope of personal jurisdiction under the Bankruptcy Code.  This post looks at the opinion in Uni-Marts and the basis by which bankruptcy courts extend jurisdiction.


Uni-Marts operates company-owned, franchise operated stores throughout the northeast.  Charan Trading Company and Varni LLC (“Plaintiffs”) purchased a store from Uni-Marts in 2005, however, by 2008 Plaintiffs filed an adversary action in Uni-Marts’ bankruptcy proceeding seeking to rescind the contract and recover damages.  Plaintiffs’ sued Uni-Marts, as well as its president,  Henry Sahakian, alleging Sahakian induced Plaintiffs to purchase the Uni-Marts store in Wilkes-Barre, Pennsylvania through fraud or negligent misrepresentation.

Sahakian sought to dismiss the adversary proceeding under Fed.R.Civ.P. 12(b)(2) & (6), made applicable under Bankruptcy Court Rule 7012(b).  Sahakian argued that the Bankruptcy Court lacked personal jurisdiction over him.


Bankruptcy Rule 7004(f) addresses the personal jurisdiction of bankruptcy courts.  The Rule provides in pertinent part that “serving a summons … is effective to establish personal jurisdiction over the person of any defendant with respect to a case under the Code or a civil proceeding arising under the Code, or arising in or related to a case under the Code.”  Federal Rule of Civil Procedure 4(k)(1)(A) limits personal jurisdiction over non-resident defendants to a court of general jurisdiction in the forum state.  Even so,  Fed.R.Civ.P. 4(k)(1)(C) broadens personal jurisdiction of the courts where service of process is “authorized by federal statute.”  The Court therefore began its analysis in Uni-Marts by stating that Bankruptcy Rule 7004(d), in allowing nationwide service of process, is the type of “federal statute” that creates an exception to Rule 4(k)(1)(C).

The Court cited the Third Circuit’s decision in Max Daetwyler Corp. v. Meyer, for its holding that to impose personal jurisdiction of the federal courts requires that minimum contacts exist between the non-resident defendant and the forum which the court exercising jurisdiction sits.  762 F.2d 290, 293 (3d Cir. 1985)(citing International Shoe Co. v. Washington, 326 U.S. 310, 316 (1945).  However, the Court further reasoned that the minimum contacts in bankruptcy proceedings are expanded to a “national contacts” standard, not “Delaware contacts,” when determining whether the bankruptcy court has jurisdiction.  Thus, in bankruptcy proceedings, the applicable forum is the United States, not the state in which the debtor filed.

Even though a “national contacts” standard is applied, courts must still determine whether the defendant directed his activities to residents of the forum.  Further,  such activities must be sufficient to support jurisdiction in any litigation for injuries arising from those activities.  Burger King Corp. v. Rudzewicz, 471 U.S. 462, 472 (1985).  The Court in Uni-Marts also relied on Burger King for its holding that a defendant’s lack of physical contacts with a jurisdiction does not defeat personal jurisdiction.

Given that the jurisdictional issues in Uni-Marts were raised in a motion to dismiss, the Court construed facts alleged in the Plaintiff’s complaint as true.  Because Plaintiffs did not make any allegations regarding Sahakian’s residence or domicile, the Court treated him as a non-resident of the forum.  Even so, the Court noted that Plaintiffs alleged Sahakian purposely directed his activities at the Plaintiffs and that the current suit brought by the Plaintiffs arose out of or related to Sahakian’s activities (his activities being that he provided documents containing false or misleading sales documents).  Based on these allegations, the Court found that “even if Sahakian was directing this activity from outside the United States,  the Plaintiff’s allege that he directed tortuous activities at the Plaintiff inside the United States.”  Taking the Plaintiff’s allegations as true, the Court found that minimum contacts existed.

The Court concludes its analysis by looking at whether extending jurisdiction comports with “traditional notions of fair play and substantial justice.”  Once a plaintiff makes its case regarding minimum contacts, the burden shifts to the defendant to show that jurisdiction would be unreasonable.  Sahakian argued that he would be unreasonably burdened by having to defend the adversary proceeding in Delaware.  However, the Court found that the issue is not whether it is burdensome to litigate in Delaware, but instead whether it is burdensome to litigate within the United States.  In the end, the Court found that Defendant failed to carry his burden of showing that jurisdiction over him offended “fair play and substantial justice.”  See Imo Indus., Inc., v. Kiekert AG, 155 F.3d 254, 259 (3rd Cir. 1998).


Foamex International Inc. (“Foamex” or “Debtors”), located in Media, Pennsylvania, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on February 18, 2009.  Foamex is one of the largest manufacturers of polyurethane and polymer foam products. (Read Foamex’s Declaration in Support of First Day Motions here).  Foamex generated $980 million in revenue for the four quarters ending in September 2008.  Foamex operates facilities in the United States, Canada, Mexico and China and manufactures goods that fall into four categories:  technical products, foam products, automotive products and carpet cushion products.

The Critical Vendor Motion

One of the first motions Foamex filed in its bankruptcy was a Motion to Honor Prepetition Obligations with Critical Vendors (the “Critical Vendor Motion”).  Pursuant to the Critical Vendor Motion,  Foamex sought an Order from the Court allowing it to pay prepetition obligations to critical vendors up to $29 million.  Foamex sought to pay the prepetition invoices for those vendors that agree to deal with it during bankruptcy under “normal trade terms.”

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.


In September of last year,  the Honorable Peter J. Walsh, the judge presiding over the NVF Company bankruptcy, issued an opinion regarding the application of section 502(b)(3) of the Bankruptcy Code.  The opinion is interesting in that the Court decided not to apply a strict interpretation to a section of the Bankruptcy Code, but instead apply an interpretation that is consistent with legislative intent.  This post looks at the issues that arise when a party seeks to disallow a claim under 502(b)(3), and look at Judge Walsh’s decision not to invoke a strict interpretation when doing so is contrary to the intent and purpose of the Bankruptcy Code.

Continue Reading Decision in NVF Bankruptcy Rejects Strict Interpretation of 502(b)(3) in Order to Provide a Result Consistent with Congressional Intent