Notable Business Bankruptcy Decisions Of 2013


In Official Committee of Unsecured Creditors v. UMB Bank, N.A. (In re Residential Capital, LLC), 2013 BL 317120 (Bankr. S.D.N.Y. Nov. 15, 2013), the court held that unamortized original issue discount ("OID") arising from fair-market-value debt exchanges should not be disallowed as unmatured interest under section 502(b) of the Bankruptcy Code. According to the court, there existed "no commercial or business reason, or valid theory of corporate finance, to justify treating claims generated by face value and fair value exchanges differently in bankruptcy" because: (i) the market value of the old debt is likely depressed in both a fair-value and a face-value exchange; (ii) OID is created for tax purposes in both fair-value and face-value exchanges; and (iii) there are concessions and incentives in both fair-value and face-value exchanges. Furthermore, the court emphasized, both kinds of exchanges offer companies out-of-court restructuring opportunities to avoid the cost and expense of a bankruptcy filing. Accordingly, the court held that the Second Circuit's ruling in LTV Corp. v. Valley Fidelity Bank & Trust Co. (In re Chateaugay Corp.), 961 F.2d 378 (2d Cir. 1992), which addressed the bankruptcy treatment of OID generated in connection with a face-value exchange (i.e., one in which the principal amount of the debt is not reduced), should control in fair-value and face-value situations.

Section 1111(b) provides that a secured claim will be treated as a recourse claim even if it is not actually recourse to the debtor by contract or under applicable state law. This means that the creditor will have a secured claim to the extent of the value of its collateral and an unsecured claim for any deficiency, unless the class of claims of which the secured creditor is a member makes a "section 1111(b) election" to have all claims in the class treated as fully secured. In In re B.R. Brookfield Commons No. 1, LLC, 2013 BL 305268 (7th Cir. Nov. 4, 2013), the Seventh Circuit concluded that "under § 1111(b)(1) (A), the existence of a valid and enforceable lien is the only prerequisite for § 1111(b)(1)(A) to apply," and hence, regardless of whether a nonrecourse second-lien claim is secured by any value in the collateral, section 1111(b)(1)(A) treats the nonrecourse claim as if it had recourse against the estate.

In In re MDC Systems, Inc., 488 B.R. 74 (Bankr. E.D. Pa. 2013), the court rejected the majority view concerning which law should be consulted to calculate the cap on future rent claims under section 502(b)(6) of the Bankruptcy Code. The court ruled that "[i]n no sense should the state law determination of whether a 'surrender' or 'repossession' occurred such as would eliminate any future claim for rent reserved control the [Bankruptcy Code's limitation on landlord claims]."


In In re Pax Am. Dev., LLC, 2013 BL 317133 (Bankr. C.D. Cal. Nov. 15, 2013), the bankruptcy court, relying on the Ninth Circuit's ruling in Tilley v. Vucurevich (In re Pecan Groves of Arizona), 951 F.2d 242 (9th Cir. 1991), held that, because the only legal beneficiaries of the automatic stay are the debtor and the bankruptcy trustee, a creditor does not have standing to seek damages for violation of the automatic stay.

By contrast, in In re Killmer, 2013 BL 317124 (Bankr. S.D.N.Y. Nov. 15, 2013), the court ruled that "[s]ince the automatic stay is meant to prevent creditors from racing to the courthouse to the detriment of other creditors, the Court sees no reason why a creditor who has been harmed by a stay violation should not be able to seek redress for its injury."

In In re Ampal-American Israel Corp., 2013 BL 345421 (Bankr. S.D.N.Y. Dec. 16, 2013), the court similarly concluded that a creditor has standing to seek damages for violation of the automatic stay and that, if the creditor is an individual, he or she may seek damages for willful violation of the stay under section 362(k) of the Bankruptcy Code. However, because the complaining individuals were former officers and directors of the debtor (i.e., potential litigation defendants), the court ruled that the movants lacked "prudential" standing, since they: (i) lacked creditor status; and (ii) were complaining about a third party's potential assertion of estate claims (which, if true, would cause only generalized rather than specific injury).


In re Tronox Inc., 2013 BL 344086 (Bankr. S.D.N.Y. Dec. 12, 2013), raised "issues of first impression regarding the application of the fraudulent conveyance laws in the face of significant environmental and tort liability." The bankruptcy court ruled that entities which orchestrated the divestiture of a group of companies' oil and gas assets valued at approximately $14 billion, while leaving the companies with billions in legacy environmental and tort liabilities, acted with intent to "hinder and delay" the companies' creditors and that the spinoff transaction was consequently avoidable in the chapter 11 cases of the debtor companies as an actual fraudulent transfer under Oklahoma's version of the Uniform Fraudulent Transfer Act and section 544(b) of the Bankruptcy Code. The court also ruled that the transaction was avoidable as a constructively fraudulent transfer because the debtors were rendered insolvent as a consequence of the spinoff transaction and did not receive reasonably equivalent value in exchange.

The court determined that the debtors were entitled to recover damages but that the transferee defendants would be entitled to a claim against the bankruptcy estates under section 502(h) of the Bankruptcy Code in the amount of whatever damages they could prove they suffered as a consequence of avoidance. The bankruptcy court rejected the defendants' argument that the transferee of an avoided fraudulent transfer is always entitled to a section 502(h) claim equal to the amount of the avoided transfer, but it left for another day a calculation of the allowed amount of the claim. That calculation will require consideration of, among other things, the percentage dividend realized by general unsecured creditors under the debtors' confirmed chapter 11 plan and whether the percentage dividend should be adjusted to account for the "dilutive effect" of inclusion of the section 502(h) claim in the creditor pool.

In The Majestic Star Casino, LLC v. Barden Development, Inc. (In re The Majestic Star Casino, LLC), 716 F.3d 736 (3d Cir. 2013), the Third Circuit considered as a matter of first impression whether a nondebtor company's decision to abandon its classification as an "S" corporation for federal tax purposes— forfeiting the pass-through tax benefits that the parent company and its chapter 11 debtor subsidiary had enjoyed—is void as a postpetition transfer of "property of the bankruptcy estate" or is avoidable under sections 362, 549, and 550 of the Bankruptcy Code. Rejecting the rationale of In re Trans- Lines West, Inc., 203 B.R. 653 (Bankr. E.D. Tenn. 1996), and its progeny, the Third Circuit ruled that S-corp status is neither "property" nor "property of the estate" within the meaning of section 541 of the Bankruptcy Code and, consequently, that the parent company's actions were not void or avoidable.

In Paloian v. LaSalle Bank, N.A., 619 F.3d 688 (7th Cir. 2010), the Seventh Circuit ruled as a matter of first impression that the trustee of a securitized investment pool can be a "transferee" within the meaning of section 550(a)(1) of the Bankruptcy Code for the purpose of avoiding transfers. However, the court of appeals rejected a bankruptcy court's finding that a chapter 11 debtor was insolvent by valuing its contingent liabilities at 100 percent, while valuing contingent assets at zero, and it remanded the case below for further findings on the issue of solvency. As part of that analysis, the bankruptcy court had considered whether a purportedly bankruptcy-remote special purpose entity ("SPE") formed as a subsidiary of the chapter 11 debtor whose sole purpose was to purchase and hold the debtor's receivables was truly a separate entity and therefore bankruptcy-remote.

On remand, the bankruptcy court ruled in Paloian v. LaSalle Bank, N.A. (In re Doctors Hosp. of Hyde Park, Inc.), 2013 BL 273656 (Bankr. N.D. Ill. Oct. 4, 2013), that the SPE was indeed "operationally" separate and distinct from the debtor. Cognizant of the repercussions for the distressed lending industry if it concluded otherwise, the court wrote that "[an SPE's] status as an independent economic unit is the entire basis on which the lender chooses to extend credit" and that there is "good reason to avoid judicial disruption of commercial transactions based on a balancing of factors susceptible to subjective interpretation." The bankruptcy court dismissed the fraudulent transfer claims because the trustee failed to establish that the debtor was insolvent or that the payments the trustee sought to recover were made with the debtor's property (as distinguished from the SPE's property).

In Richardson v. Checker Acquisition Corp. (In re Checker Motors Corp.), 495 B.R. 355 (Bankr. W.D. Mich. 2013), the court held that: (i) insolvency for the purpose of avoiding a constructive fraudulent transfer under section 548(a)(1)(B) of the Bankruptcy Code is determined solely on the basis of claims within the meaning of the definition of "claim" in section 101(5); and (ii) a chapter 11 debtor's withdrawal liability from a multi-employer pension plan does not become a "claim" within the meaning of section 101(5) until the debtor has actually withdrawn from the plan. The court ruled that the chapter 1 1 trustee could not rely upon the debtor's potential withdrawal liability to establish constructive fraud under section 548(a)(1)(B) because the debtor had not withdrawn from the multi-employer plan prior to the commencement of its bankruptcy case.


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