Ritzen Group, Inc. v. Jackson Masonry, LLC, 140 S. Ct. 582 (2020). The Ritzen Group, Inc. agreed to buy real property in Nashville, Tennessee, from Jackson Masonry, LLC. The transaction was never consummated and Ritzen sued for breach of contract in state court. Days before trial was set to begin, Jackson filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code. Section 362(a) of the Bankruptcy Code stayed the litigation. Ritzen filed a motion in the bankruptcy court for relief from the automatic stay. The bankruptcy court denied the motion. The bankruptcy court, in the context of an adversary proceeding, found that Ritzen was in breach of the contract because it had failed to secure the financing by the closing date. Accordingly, the bankruptcy court disallowed Ritzen’s proof of claim. Thereafter, the plan of reorganization was confirmed and all creditors were enjoined from commencing or continuing any proceeding against the debtor on account of claims. Following confirmation, Ritzen filed two separate notices of appeal. First, Ritzen challenged the bankruptcy court’s order denying stay relief. Second, Ritzen challenged the court’s resolution of its breach of contract claim. The district court, acting as the appellate court of first instance, dismissed the first appeal as untimely pursuant to 28 U.S.C. § 158(c)(2) and Rule 8002(a) of the Federal Rules of Bankruptcy Procedure. With respect to Ritzen’s appeal of the breach of contract claim, the district court rejected the appeal on the merits. The United States Court of Appeals for the Sixth Circuit affirmed.

The Supreme Court granted certiorari to resolve the question of whether orders denying relief from the automatic stay are final and, therefore, immediately appealable under Section 158(a)(1). Justice Ginsburg, delivering the opinion for a unanimous court, began by noting that a majority of the circuit courts and the leading treatises consider orders denying relief from the automatic stay as final, immediately appealable decisions. The Court agreed.

Jackson argued that adjudication of a stay-relief motion was a discrete proceeding, whereas Ritzen argued that it should be considered as the first step in the process of adjudicating a creditor’s claim against the estate. The Supreme Court agreed with the appellate court and Jackson that the appropriate “proceeding” is the stay-relief adjudication. The bankruptcy court’s order ruling on that motion disposed of “a procedural unit anterior to, and separate from, claim-resolution proceedings.” The Court noted that “[m]any motions to lift the automatic stay do not involve adversary claims against the debtor that would be pursued in another form but for bankruptcy. Bankruptcy’s embracive automatic stays stops even non-judicial efforts to obtain or control the debtor’s assets.” The Court reasoned that there was “no good reason to treat stay adjudication as the relevant ‘proceeding’ in only a subset of cases.” Because the appropriate “proceeding” was the adjudication of the stay-relief motion, the bankruptcy court’s order conclusively denying that request was “final.” It ended the stay-relief proceedings and left nothing more for the bankruptcy court to do. Accordingly, the appeal was untimely. The Court held that “the adjudication of a motion for relief from the automatic stay forms a discrete procedural unit within the embracive bankruptcy case. The unit yields a final, appealable order when the bankruptcy court unreservedly grants or denies relief.”

§ 1.1.2 First Circuit

Mission Prod. Holdings, Inc. v. Schleicher & Stebbins Hotels, LLC (In re Old Cold, LLC), 976 F.3d 107 (1st Cir. 2020). In the most recent litigation connected to the bankruptcy proceedings of Old Cold, LLC (the “Debtor”)—notable for spawning the Supreme Court’s decision in Mission Prod. Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019)—Mission Product Holdings, Inc. (“Mission”), a licensee of certain of the Debtor’s intellectual property, challenged the ability of the Debtor’s only secured creditor (and DIP lender), Schleicher & Stebbins Hotels, L.L.C. (“S & S”), to foreclose on the assets remaining in the Debtor’s estate following a section 363 sale process. In its decision, the First Circuit Court of Appeals held first that Mission’s failure to obtain a stay of the bankruptcy court order lifting the automatic stay did not moot the appeal before turning to the merits of Mission’s appeal. The First Circuit then affirmed the bankruptcy court order on the merits, overruling Mission’s arguments that Mission’s petition for certiorari divested the bankruptcy of jurisdiction on the lift stay motion and that S & S had implicitly waived its lien on certain Debtor assets when it agreed to exclude them as part of its bid during the course of the section 363 auction.

In 2015, the Debtor moved to sell all of its assets at auction pursuant to section 363 of the Bankruptcy Code. S & S, the Debtor’s DIP lender, agreed to be a stalking horse bidder, with authority from the bankruptcy court to credit bid pursuant to section 363(k). After a competitive bidding process, S & S’s bid, which excluded certain cash assets of the Debtor, was declared the successful bid and S & S entered into an Asset Purchase Agreement (APA) with the Debtor.

In 2018, S & S filed a motion for relief from the automatic stay, to which the Debtor assented, seeking to recover the then-sole remaining asset of the Debtor’s estate—$527,292 in cash that had been excluded from the 363 sale—by foreclosing on its valid, first-priority, perfected liens on the Debtor’s assets that it had received as a DIP lender. Mission objected, arguing that its then-pending petition for a writ of certiorari arising from a separate litigation related to the termination of certain exclusive and nonexclusive intellectual property licenses divested the bankruptcy court of jurisdiction to decide the stay relief motion because, if stay relief were granted, S & S would look to the assets of the estate, including the cash that was subject to S & S lien, to satisfy any potential judgment. Second, it argued that S & S no longer had a security interest in that property because, as part of the auction and sale, S & S had supposedly agreed either to recontribute those assets back into the estate free and clear of its liens or to waive those liens as part of the bidding process. The bankruptcy court granted the stay relief motion, overruling Mission’s objections.

Mission sought a stay of the relief order from the bankruptcy court pending its appeal, which the bankruptcy court granted in part, extending the automatic fourteen-day stay of such orders so that Mission could seek a further stay of the relief order from the BAP. In November 2018, the BAP denied Mission’s request for a further stay, concluding that Mission had not shown a likelihood of success on the merits or irreparable injury absent relief. Upon expiration of Mission’s stay pending appeal, S & S demanded the remaining cash from the Debtor, and the Debtor complied. The BAP then affirmed the bankruptcy court, concluding that both it and the bankruptcy court had jurisdiction to rule on the stay relief motion and that the bankruptcy court did not abuse its discretion in granting S & S relief from the stay.

On appeal, the First Circuit held that Mission’s failure to obtain a stay of the relief order and the subsequent disbursement of the Debtor’s remaining assets did not moot the appeal under Article III, the provisions of the Bankruptcy Code and rules, and equitable principles. The court dismissed S & S’s arguments that the failure to obtain a stay pending appeal of the bankruptcy court’s order mooted any appeal. Instead, the court noted that Mission was seeking a disgorgement of cash paid to S & S, and that a request for such relief did not result in “meaningful appellate relief [being] no longer practicable.” The court also held that the granting of Mission’s petition for a writ of certiorari did not divest the bankruptcy court of jurisdiction to decide the stay relief motion, holding that it could order a disgorgement in this case if S & S had no right to the assets, and noted that the Supreme Court recognized that the disbursement of the cash had no impact on its ability to decide Mission’s appeal as long as there was “any chance of money changing hands.” Mission Prod. Holdings, 139 S. Ct. at 1660. Lastly, the court rejected Mission’s challenge to the bankruptcy court’s order granting S & S the requested relief from the automatic stay. Mission’s primary argument was that S & S impliedly waived its liens on the Debtor’s property, as demonstrated by the discussion at the auction of a commitment to match Mission’s treatment of some Debtor assets by leaving them behind in the estate. The court noted that Mission’s unsuccessful bid, let alone the prevailing bid, could not have eliminated any liens on the estate, as Mission did not have the power to eliminate S & S’s liens on the Debtor’s assets merely by agreeing to leave the assets in the estate. As the court stated, “[t]he Bankruptcy Code itself plainly protects a security interest even when the assets to which the interests attach are sold in a section 363(f) sale, 11 U.S.C. § 363(e), which often means that those security interests attach to the proceeds of the sale.” The court pointed out that “[i]t would be strange indeed to conclude that an auction that did not even result in the sale of that same asset would somehow destroy the security interest.”

Fin. Oversight & Mgmt. Bd. for P.R. v. Andalusian Glob. Designated Activity Co. (In re Fin. Oversight & Mgmt. Bd. for P.R.), No. 19-1699 (Jan. 30, 2020). In one of the latest decisions stemming from the proceedings under Title III of the Puerto Rico Oversight Management and Economic Stability Act (“PROMESA”), the First Circuit recently affirmed the finding of the court overseeing the Title III proceedings (the “Title III Court”) that the security interest held by holders of municipal bonds (“Bondholders”) issued by the Employees Retirement System of the Government of the Commonwealth of Puerto Rico (the “System”) did not extend to postpetition, statutorily required employer contributions to the Systems over the Bondholders’ opposition, overruling the Bondholders’ various arguments on the basis of section 552 of the Bankruptcy Code that the liens did extend to postpetition employer contributions.

The System is an independent agency of the Commonwealth that provides pensions and retirement benefits to employees and officers of the Commonwealth government, municipalities, and public corporations, as well as employees and members of the Commonwealth’s Legislative Assembly. The System was funded through mandatory contributions from both employers and employees, as well as investment income. In 2008, the statute authorizing the System was amended to authorize the System to issue bonds. On January 24, 2008, the System’s Board adopted a resolution to issue $2.9 billion in bonds. Per the resolution, the bonds would be secured by, among other things, “All Revenues” and proceeds thereof, where “Revenues” includes “Employers’ Contributions.” The System also executed a security agreement with the Bondholders, which granted them a security interest in the property discussed above and “all proceeds thereof and all after-acquired property, subject to application as permitted by the Resolution.”

In 2016, shortly after the enactment of PROMESA, Puerto Rico and its various agencies, including the System, filed petitions for relief under Title III of PROMESA. Sometime thereafter, the System sought a declaratory judgment against the Bondholders as to the “validity, priority, extent and enforceability” of the Bondholders’ asserted security interest in the System’s postpetition assets, including employer contributions received postpetition. The Bondholders argued, both before the Title III Court and the First Circuit, that (i) their security interest extended to postpetition employer contributions by virtue of section 552(b)(1), incorporated into PROMESA by 48 U.S.C. § 2161(a); (ii) the section 552(a) bar did not apply pursuant to the exception under section 928, incorporated into PROMESA by 48 U.S.C. § 2161(a); and (iii) applying the section 552(a) bar to postpetition employer contributions amounted to a Fifth Amendment taking. The First Circuit addressed and rejected each of the Bondholders’ arguments in turn.

The court held that the postpetition employer contributions did not qualify as “proceeds” within the meaning of section 552(b)(1). The court analyzed the System’s statutory authority to receive postpetition Employers’ Contributions, distinguishing between the System’s expectancy in future contributions and a “property right.” The court found that, since the amount of Contributions depended on work occurring on or after the petition date, the statutory merely afforded the System an expectancy in postpetition contributions, not a property right in postpetition contributions. As a result, the Bondholders lacked any secured interest in the property that could produce postpetition “proceeds” to which they could be entitled under section 552(b)(1).

The court further held that the employer contributions were not “special revenue” as contemplated by section 928 of the Bankruptcy Code. Looking at sections 902(2)(A) and 902(2)(D) of the Bankruptcy Code, the court noted that the analysis turned on whether the Employers’ Contributions are “derived from” the ownership or operation of “other services” provided by the System or the “particular functions” of the System. Pointing to the plain language of the statute, the First Circuit held that the “special revenue” provisions could not apply because neither the System’s “particular function” nor its “ownership” or “operation” of providing pension services produced any revenue. Because the System merely functioned as a “conduit for the distribution of Employers’ Contributions,” the contributions themselves could not be properly characterized as revenue produced by the System. Therefore, the Employers’ Contributions did not qualify as “special revenue” under sections 902(2)(A) or 902(2)(D) of PROMESA.

Finally, the court ruled that there could be no impermissible taking under the Fifth Amendment because Congress clearly intended section 552 to apply retroactively to security interests created before the enactment of PROMESA. In so doing, the court overruled the Bondholders’ argument that, because section 552 did not apply to the Bondholders’ liens when the bonds were authorized, it could not be applied to the Bondholders’ liens now by virtue of PROMESA without raising “grave constitution questions.”

In re Montreal, Maine & Atlantic Railway, Ltd., 956 F.3d 1 (2020). The First Circuit affirmed a ruling that a secured creditor could not object to the release of claims, over which the creditor purportedly had a security interest, as part of a settlement where the creditor had failed to prove the value of the claims being released.

In 2013, a train carrying crude oil, arranged by Western Petroleum Company and affiliates (“Western”), derailed, causing a fire that killed 48 people. Soon after, the train operator, Montreal, Maine & Atlantic Railway, Ltd. (the “Debtor”), filed a Chapter 11 petition in the District of Maine for the purpose of liquidating its assets. At the time of filing, the Debtor’s secured creditors included Wheeling & Lake Erie Railway Co. (“Wheeling”), which extended a $6 million secured line of credit to the Debtor in 2009. Wheeling’s collateral included the Debtor’s accounts and other rights to payment, which encompassed any non-tort claims accrued by the Debtor.

In January 2014, the Debtor brought suit against Western to resolve liability between itself and Western. The parties ultimately agreed to settle the suit, with Western agreeing, among other things, to pay $110 million for the benefit of the derailment victims in exchange for a release by the Debtor of its non-tort claims against Western, which constituted part of Wheeling’s collateral. The bankruptcy court approved the settlement and confirmed the Debtor’s liquidating Chapter 11 plan over Wheeling’s objection, although the confirmed plan reserved Wheeling’s right to contend that its security interest attached to the settlement payments made in consideration of the released claims.

During a subsequent trial of the issue of whether Wheeling was entitled to compensation for the release of its non-tort claim collateral, the bankruptcy court held that (i) the Debtor did not have any cognizable non-tort claims against Western, and (ii) that even if the claims did exist, Wheeling had not carried its burden to establish the value of those claims in accordance with section 506(a)(1). Wheeling had relied solely on the value of the economic damages as stipulated between Wheeling and the Debtor to support its contentions regarding value of the claim.

On appeal, the First Circuit affirmed the bankruptcy court. The court held that, even assuming that the estate held cognizable non-tort claims against Western in which Wheeling held a security interest, there was “no clear error in the bankruptcy court’s finding that Wheeling failed to carry its burden of proving the value of the non-tort claims.” The court reasoned that a claim’s settlement value involves many different factors, including, inter alia, the strength of the evidence, the viability of any defenses, the ability of the defendant to satisfy a judgment, and the litigation cost. Wheeling’s stipulated “net economic damages” estimate was “plainly insufficient” to satisfy its burden of proving the value of its collateral by enabling the bankruptcy court either to assess the likelihood of recovery or to “gauge any of the relevant factors other than the estate’s potential recovery that may have affected the settlement value of the non-tort claims.” Nor did Wheeling offer any expert testimony concerning a range of value for the settlement of non-tort claims.

§ 1.1.3 Second Circuit

In re Lehman Bros. Holdings Inc., 792 F. App’x 16 (2d Cir. 2019). The Second Circuit upheld the determination of the bankruptcy court that former employees of Lehman Brothers Inc. (“LBI”), who had agreed to defer portions of their compensation into a deferred pension plan in return for tax benefits and a favorable interest rate, were bound by subordination provisions contained in the plan agreements. The court found that the claims were clearly and unambiguously subordinated.

In the 1980s, Shearson Lehman Brothers Inc., a predecessor entity to LBI, created deferred compensation plans for certain executives called the Executive and Select Employees Deferred Compensation Plan (the “ESEP Agreements”). The ESEP Agreements explicitly provided that “the obligations of Shearson hereunder with respect to the payment of amounts credited to his deferred compensation account are and shall be subordinate in right of payment and subject to the prior payment or provision for payment in full of all claims of all other present and future creditors of Shearson whose claims are not similarly subordinated…” After LBI’s collapse and the commencement of liquidation proceedings, the former employees submitted claims in connection with their deferred compensation under the ESEP Agreements. Pursuant to the ESEP Agreements, the Trustee determined that these claims were subordinated.

The former employees sought to avoid the subordination provisions on the basis that (1) the subordination provisions only applied to Shearson Lehman Brothers Inc., not LBI; (2) LBI materially breached the ESEP Agreements and, thus, could not compel performance; and (3) the ESEP Agreements were rejected executory agreements. These arguments were rejected by the bankruptcy court and the district court. The Second Circuit found that LBI was a continuation of Shearson Lehman Brothers Inc. and a series of name changes was not sufficient to prevent application of the subordination provisions. The court further determined that any breach was irrelevant because the Trustee was not trying to compel performance, but rather merely to classify the former employees’ claims. Similarly, the court found that whether the ESEP Agreements were rejected executory contracts would have no impact on the subordination provisions.

Marsh USA, Inc. v. The Bogdan Law Firm (In re Johns-Manville Corp.), No. 18-2531(l) (2d Cir. Feb. 19, 2020). The U.S. Court of Appeals for the Second Circuit held that the appointment of a future claims representative ensured future asbestos-related claimants sufficient due process to be barred by the asbestos channeling injunction entered in 1986 in the Johns-Manville bankruptcy.

Salvador Parra, Jr. (“Parra”) argued that asserted state-law, asbestos-related claims against Marsh, a former insurance broker for Johns Manville, should not be enjoined and channeled into the trust. He argued that the channeling injunction should not be enforceable against him because he had not received sufficient due process during the Manville bankruptcy proceeding. The bankruptcy court rejected Parra’s argument, finding that the injunction was enforceable because Parra’s interests were represented in absentia by the future claims representative (the FCR) that was appointed during the Manville bankruptcy. The bankruptcy court held that the FCR represented future claimants as to both their in rem and in personam claims. The district court reversed.

The Second Circuit affirmed the bankruptcy court, finding no clear error where the bankruptcy court had relied on evidence in the bankruptcy proceedings demonstrating that the FCR had, in fact, argued against the order channeling in personam claims to the trust in 1985. Thus, the bankruptcy court concluded, the FCR was engaged to advocate for future claimants in connection with their potential in personam claims, as well as their potential in rem claims.

The Second Circuit further held that the notice provided to future claimants “was constitutionally sufficient” because it “was designed to inform as many future asbestos claimants as possible . . . [about the] proceedings,” including national TV and radio ads and newspaper ads in U.S. and Canadian newspapers.

In re Motors Liquidation Company, 957 F.3d 357 (2d Cir. 2020). The Second Circuit held that the new General Motors (“New GM”) did not contractually assume liability for punitive damages arising from post-closing accidents involving cars produced by its predecessor (“Old GM”) when it purchased Old GM’s assets in a bankruptcy sale.

Following General Motors’ bankruptcy filing in June 2009, New GM purchased substantially all of Old GM’s assets. The sale agreement provided that the purchaser would assume the liability of Old GM with respect to post-sale accidents involving automobiles manufactured by Old GM, including claims by those who did not transact business with Old GM (such as individuals who never owned Old GM vehicles and persons who bought Old GM used cars after the bankruptcy sale). When New GM recalled certain Old GM vehicles in 2014, a number of lawsuits followed, including suits seeking punitive damages. New GM moved the bankruptcy court to enforce the “free and clear” terms of the sale order. In a November 2015 decision, the bankruptcy court determined that New GM could not be liable for punitive damages by reason of the conduct of Old GM.

In July 2017, the bankruptcy court again revisited its decision when certain claimants argued that they were not bound by the November 2015 decision on the basis that they were not party to the bankruptcy proceedings. The bankruptcy court reaffirmed its November 2015 decision, applying it as “law of the case.” The District Court affirmed and the claimants appealed.

On appeal, the Second Circuit considered not only whether the bankruptcy court correctly interpreted the sale order and agreement, but also whether res judicata applied. On the res judicata point, the court held that because the appellants were not served with notice of the scheduling order in connection with the November 2015 decision, there was not a sufficient identity between the litigants such that res judicata would apply. When considering the sale agreement, the Second Circuit concluded that New GM did not assume liability for punitive damages because punitive damages neither provide compensation “for” death and injuries, nor “ar[i]se directly out of” death and injuries. Finally, the court held that the appellants could not escape language in the sale order providing that the sale “shall be free and clear of all liens, claims, encumbrances and other interests of any kind or nature whatsoever . . . , including rights or claims based on any successor or transferee liability,” solely by virtue of the fact that they had no relationship with Old GM at the time the sale order was entered. The court dismissed this argument, determining that the issue of successor liability had no impact on whether New GM assumed liability for punitive damages.

In re Tribune Co. Fraudulent Conveyance Litig., 946 F.3d 66 (2d Cir. 2019). In the wake of the Supreme Court’s decision in Merit Management Group., LP v. FTI Consulting, Inc., 138 S. Ct. 883 (2018), the Second Circuit was asked to revisit its decision in In re Tribune Co. Fraudulent Conveyance Litigation, 818 F.3d 98 (2d Cir. 2016). Because the Second Circuit determined that the holding in Merit Management did not address the question of whether section 546(e) preempts the creditors’ state law, constructive fraudulent conveyance claims, it reaffirmed its prior decision, which upheld the dismissal of the creditors’ state law, constructive fraudulent conveyance claims on preemption grounds.

In 2007, a struggling Tribune Media Company (“Tribune”) cashed out its shareholders in a leveraged buyout (“LBO”) for more than $8 billion. Tribune effectuated the LBO by transferring the $8 billion sum, at least in part, to Computershare Trust Company, N.A. (“Computershare”), which acted as depositary in connection with the LBO. In its capacity as depositary, Computershare received and held Tribune’s deposit of the aggregate purchase price for the shares and then received the tendered shares on Tribune’s behalf, and paid the tendering shareholders.

On December 8, 2008, Tribune and nearly all of its subsidiaries filed for bankruptcy in the District of Delaware. An official committee of unsecured creditors (the “Committee”) was appointed. In November 2010, the Committee commenced an action for an intentional fraudulent conveyance under section 548(a)(1)(A) of the Bankruptcy Code against the cashed-out Tribune shareholders, various officers, directors, financial advisors and others who allegedly profited from the LBO. Two subsets of unsecured creditors subsequently moved the bankruptcy court to rule that (i) after the expiration of the two-year statute of limitations period during which the Committee was authorized to bring avoidance actions under section 546(a), eligible creditors regained the right to prosecute their state law creditor claims; and (ii) the automatic stay was lifted to permit filing of such complaints. The bankruptcy court granted the relief sought in April 2011. In June 2011, the creditors filed state law, constructive fraudulent conveyance claims in various federal and state courts, alleging that the LBO payments were for more than the reasonable value of the shares and were made at a time when Tribune was in financial distress. These complaints were consolidated, along with the Committee’s complaint (now being prosecuted by a litigation trust pursuant to Tribune’s now-confirmed plan), in a multi-district litigation proceeding before the Southern District of New York.

After consolidation, the Tribune shareholders moved to dismiss the creditor’s state law, constructive fraudulent conveyance claims. The district court granted the motion to dismiss on the grounds that the automatic stay prevented the creditors from having statutory standing to assert such claims while the litigation trust was pursuing avoidance of the same transfers under a theory of intentional fraud. The district court rejected the Tribune shareholders’ argument that section 546(e) barred the creditors’ actions because the statute referred only to actions brought by a bankruptcy trustee. The creditors appealed on the dismissal for lack of statutory standing, while the Tribune shareholders cross-appealed the rejection of their argument that the creditors’ claims were preempted by section 546(e). The Second Circuit affirmed on the basis that section 546(e) preempts fraudulent conveyance actions, even those brought by creditors, as long as they fall within the statutory parameters of section 546(e). Section 546(e) covers transfers “made by or to (or for the benefit of) a … financial institution … in connection with a securities contract, as defined in section 741(7).” 11 U.S.C. § 546(e).

While the creditors pursued further appellate relief, the Supreme Court handed down its decision in Merit Management, which held that section 546(e) did “not protect transfers in which financial institutions served as mere conduits.” 138 S. Ct. at 892. Following the decision, Justices Kennedy and Thomas issued a statement suggesting that the Second Circuit recall its prior mandate in this case.

First addressing the question of statutory standing, the Second Circuit held that both the bankruptcy court’s prior order and the confirmed plan ensured that the creditors’ state law, constructive fraudulent conveyance claims were not subject to the automatic stay. The bulk of the opinion, however, was spent discussing whether the creditors’ state law, constructive fraudulent conveyance claims were preempted by section 546(e).

Because Merit Management foreclosed the basis upon which the Second Circuit had originally ruled that the payments challenged by the creditors’ complaint fell within the scope of section 546(e)—that they were payments in which a “financial institution” served as an intermediary—the court had to reconsider whether either Tribune or the shareholders qualified as a covered entity under section 546(e). Looking to the definition of “financial institution” in section 101(22) of the Bankruptcy Code, the court held that, because Tribune was a customer of Computershare, which was itself a qualifying “financial institution,” and because Computershare functioned as Tribune’s agent in the LBO, Tribune was imputed to be a “financial institution” as well, pursuant to the statutory definition under the Bankruptcy Code. See 11 U.S.C. § 101(22)(A) (defining “financial institution” to include, inter alia, “an entity that is a commercial or savings bank, … trust company, … and, when any such … entity is acting as agent or custodian for a customer (whether or not a ‘customer,’ as defined in section 741) in connection with a securities contract (as defined in section 741) such customer”) (emphasis added).

After concluding not only that Tribune was an entity covered by section 546(e), but also that the transfers at issue were covered as transfers “in connection with a securities contract,” the court considered whether the presumption against preemption applied where Congress had not explicitly stated its intention that state laws should be limited by federal law. The court found that the regulation of creditors’ rights has “a history of significant federal presence,” and there was not a “significant countervailing pressure[] of state law concerns” to militate against preemption.

Lastly, the court rejected the creditors’ legal theory that, upon the filing of the bankruptcy proceeding, the bankruptcy trustee merely interrupts the creditor’s ability to bring state law avoidance claims. Rather, the court held that the causes of action become part of the bankruptcy estate, meaning that they become subject to the limitations of section 546(e) in all respects. The termination of the bankruptcy trustee’s ability to bring the claims does not somehow remove the limitation of section 546(e) from the claims.

Accordingly, while the Supreme Court may have limited the ability to use section 546(e) as a shield in connection with LBOs by the mere presence in the transaction of a “financial institution,” the Second Circuit has ensured that LBO transactions remain unavoidable, holding that customers of “financial institutions” will also merit protection under section 546(e).

§ 1.1.4 Third Circuit

In re Millennium Lab Holdings, LLC, 945 F.3d 126 (3d Cir. 2019). In a narrow ruling on “exceptional facts,” the Third Circuit affirmed that bankruptcy courts have jurisdiction to confirm plans of reorganization that contain nonconsensual third-party releases and injunctions, but only if the releases satisfy the parameters laid out in Stern v. Marshall, 564 U.S. 462 (2011)—that the matter must be integral to the restructuring of the debtor-creditor relationship, notwithstanding whether the matter is dedicated by federal statute to the “core” jurisdiction of the bankruptcy court.

Millennium Lab Holdings, II, LLC and its wholly owned subsidiaries (collectively, “Millennium”) were providers of laboratory-based diagnostic services that entered into a $1.825 billion credit agreement with multiple lenders including certain funds managed by Voya Investment Management Co. LLC and Voya Alternative Asset Management LLC (collectively, “Voya”). Millennium’s main shareholders were TA Millennium, Inc. (“TA”) and Millennium Lab Holdings, Inc. (“MLH”). Millennium used the funds from the credit agreement to refinance certain existing debts while also paying almost $1.3 billion in dividends to shareholders. Following a Department of Justice investigation, Millennium agreed to settle certain claims with various government entities for $256 million, which left Millennium unable to satisfy its obligations under the credit agreement.

Certain creditors formed an ad-hoc group to negotiate with Millennium to restructure its obligations, resolve other potential claims against it, and enable Millennium to pay the settlement with the government. A restructuring support agreement was negotiated under which TA and MLH would pay $325 million and relinquish their equity interests in exchange for full releases under Millennium’s plan of reorganization, including the release of claims related to the credit agreement. However, Voya refused the terms of the restructuring support agreement, preferring instead to preserve its legal claims in connection with the credit agreement. When Millennium filed for Chapter 11 protection, seeking approval of a prepackaged plan of reorganization, Voya objected on the basis that the releases to TA and MLH were unlawful and the bankruptcy court lacked constitutional authority to approve them.

The central question before the Third Circuit was whether the bankruptcy court was “resolving a matter integral to the restructuring of the debtor-creditor relationship.” Reflecting on the Supreme Court’s decision in Stern v. Marshall, the court indicated that (1) a bankruptcy court can violate Article III even where it has statutory authority over a “core” matter; (2) a bankruptcy court is within constitutional limits where it is resolving a matter that is integral to a debtor-creditor relationship; and (3) when determining constitutional authority, the court should look to the content of the proceeding rather than focusing on the category of “core.”

The court found that the sophisticated negotiations over the restructuring agreement suggested that, absent the releases, TA and MLH would not have contributed to the restructuring and Millennium would have been liquidated. As a result, the bankruptcy court had authority to approve the plan because the releases were “integral” to the restructuring of the debtor-creditor relationship. The court was careful to limit its holding to the facts of the case and noted that the ample evidentiary record that the bankruptcy court had relied on in making its ruling was instrumental to the result of the appeal. The court also affirmed the district court’s decision that Voya’s remaining claims were equitably moot, since the plan—including the nonconsensual third-party releases—was substantially consummated and the releases could not be unwound without doing harm to the entirety of the plan.

In re Energy Future Holdings Corp., 949 F.3d 806 (3d Cir. 2020). In In re Energy Future Holdings Corp., the Third Circuit determined under what circumstances a bankruptcy court could discharge the claims of latent asbestos claimants. In a Chapter 11 reorganization plan, the discharge of latent asbestos claims was permissible as long as the claimants received an opportunity to reinstate their claims after the debtor’s reorganization that comported with due process. Because latent asbestos claimants were allowed to file proofs of claim after the bar date if they showed excusable neglect, the claimants’ right to due process was not compromised because the combination of both the pre-confirmation notice provided and the post-confirmation hearing were adequate.

Burdened with asbestos claims and liabilities, Energy Future Holdings Corporation (“EFH”) and its subsidiaries commenced Chapter 11 proceedings. However, rather than establishing a section 524(g) trust, EFH relied instead on Rule 3003(c)(3) of the Federal Rules of Bankruptcy Procedure, which authorizes a court to extend the time for filing a claim “for cause shown.” Future claimants—whose claims would be discharged by the order confirming the Chapter 11 plan—could obtain permission to file their claim after the bar date under Rule 3003(c)(3), and seek reinstatement of their discharged claims on due process grounds. The bankruptcy court accepted this approach, set a bar date, and confirmed the plan.

Several claimants who did not file claims by the bar date and later were stricken by mesothelioma (the “Claimants”) appealed the bankruptcy court’s confirmation order, arguing that (i) the failure to include a pre-discharge process for addressing claims and (ii) deferring to the Rule 3003(c)(3) mechanism each amounted to a violation of their due process rights. The district court rejected the challenge under section 363(m) of the Bankruptcy Code as statutorily moot. The Claimants appealed to the Third Circuit Court of Appeals.

The Third Circuit held that section 363(m) partially barred, but did not entirely bar, the Claimants’ appeal. The Third Circuit rejected the Claimants’ argument that there is a due process exception to section 363(m). The court also rejected that the confirmation order was not “an authorization … of a sale” within the meaning of section 363(m), or that the Claimants’ appeal would “affect the validity of [the] sale.” Based on these determinations, the court concluded that it was barred from considering the Claimants’ argument that they were entitled to a pre-discharge claims process. However, section 363(m) did not bar the Circuit Court from considering the adequacy of the Rule 3003(c)(3) procedure because the review of the Rule 3003(c)(3) process could not “affect the validity of the sale.”

The Third Circuit, therefore, turned to consider whether the Rule 3003(c)(3) process comported with due process. Although the Claimants had demonstrated that the Rule 3003(c)(3) process deprived individuals of an interest “that is encompassed within the Fourteenth Amendment’s protection of life, liberty, or property,” the Claimants failed to demonstrate that the Rule 3003(c)(3) procedures were constitutionally inadequate. EFH had published notices in consumer magazines, newspapers, union publications and Internet outlets encouraging latent claimants to file proofs of claim by the bar date. Under established law, claimants who are unknown at the time of discharge are only entitled to publication notice. However, because the bankruptcy court retained jurisdiction for the purpose of determining whether an individual latent claimant had demonstrated sufficient “cause” for filing an untimely proof of claim, adequate process was afforded.

The Third Circuit concluded by noting that this case is a “cautionary tale for debtors attempting to circumvent [section] 524(g).” While EFH’s approach resulted in a similar outcome of a section 524(g) trust, it added unnecessary litigation that could have been avoided by opting to follow the process contained in section 524(g).

In re Tribune Co., 972 F.3d 228, 235 (3d Cir. 2020). The Third Circuit affirmed the order of the U.S. Bankruptcy Court for the District of Delaware confirming the plan of reorganization of the Tribune Company and its affiliated debtors, over the objections of certain senior noteholders, holding $1.283 billion in notes issued by Tribune (the “Senior Noteholders”). The Senior Noteholders argued that (1) the bankruptcy court erred when it failed to strictly enforce the subordination provision in the indenture governing the senior notes, which required repayment of the senior notes before any other debt incurred by the company; and (2) the failure to strictly enforce the subordination provision resulted in the plan’s unfairly discriminating against the Senior Noteholders, in violation of section 1129(b)(1) of the Bankruptcy Code. The Third Circuit rejected both arguments, determining that the section 1129(b)(1) cramdown provision allows for more flexible enforcement of subordination agreements where it would increase the likelihood of a successful plan and that the bankruptcy court’s analysis of any unfair discrimination was appropriate in the circumstances.

The Tribune Company (“Tribune”) was a large media company, composed of national newspapers, regional newspapers, and television and radio stations. A failed leveraged buyout left Tribune with roughly $13 billion in debt, forcing the company to file for Chapter 11 protection. Prior to the leveraged buyout, Tribune had previously issued unsecured notes, the indenture for which contained subordination provisions that required the notes to be paid before any other company obligations. Two other debt instruments explicitly provided that they were subordinate to the Senior Noteholders: the so-called “PHONES Notes” and the “EGI Notes.”

Notwithstanding the contractual provision, which stated that the Senior Noteholders would be paid before any other debts of the company, the Tribune plan sought to subordinate the PHONES and EGI Notes—not just to the Senior Noteholders, but to certain unsecured “swap” claimants, retirees and trade creditors as well. Rather than paying the Senior Noteholders the entirety of the recovery that would have been due to the PHONES and EGI Notes, Tribune sought to reallocate those recoveries equally among the Senior Noteholders, the swap claimants, the retirees, and the trade creditors.

The Senior Noteholders objected to the plan of reorganization on the basis that the approximately $30 million in recoveries that would have been paid to the PHONES and EGI Notes in the absence of the subordination provision should have been directed solely to the Senior Noteholders, and should not be shared amongst the Senior Noteholders, the swap claimants, the retirees, and the trade creditors. As discussed above, the argument was twofold: first, the subordination should be strictly enforced pursuant to section 510(a) of the Bankruptcy Code; and, in the alternative, the plan should be rejected as unfairly discriminating against the Senior Noteholders in favor of the swap claimants, retirees, and trade creditors. The bankruptcy court rejected these arguments, in part because under the plan, the Senior Noteholders would receive an equal distribution to other similarly situated unsecured creditors. The bankruptcy court also found that the Senior Noteholders’ recovery under the plan would not be materially impacted by the reallocation of the $30 million from the PHONES and EGI Notes as contemplated by the plan versus as if the $30 million was allocated only to the Senior Noteholders and the swap claimants (who, the Senior Noteholders agreed, were also senior to the PHONES and EGI Notes). The decrease in the Senior Noteholders’ percentage recovery was 0.90%.

On appeal, the Third Circuit considered both arguments. As to the question regarding strict enforcement of the subordination provision in accordance with section 510(a), the court focused on the plain language of section 1129(b)(1), which uses the phrase “notwithstanding section 510(a).” Based on prior precedent interpreting the term “notwithstanding” in the bankruptcy context, the court held that, as used in section 1129(b)(1), “notwithstanding section 510(a)” meant “[d]espite the rights conferred by [section] 510(a).” Accordingly, section 1129(b)(1) trumped section 510(a), and the Bankruptcy Code allowed courts to flexibly construe subordination agreements when considering whether to confirm a plan vis-à-vis a cramdown under section 1129(b)(1).

As to the question regarding unfair discrimination, the court first described the different methods of analysis used by other courts to evaluate unfair discrimination: the “mechanical” test, the “restrictive” approach, the “broad” approach, and the “rebuttable presumption” test. From these different approaches, the court distilled eight principles for determining unfair discrimination: (1) plans may treat like creditors differently, but not so much as to be unfair; (2) unfair discrimination applies only to classes of creditors rather than individual creditors; (3) unfair discrimination is considered from the perspective of the dissenting class; (4) the classes must be aligned correctly; (5) the court should determine recoveries based on the present value of payments or the allocation of risk connected with the proposed distribution; (6) subordinated sums should be included when the court considers the pro rata baseline distribution to creditors of the same class; (7) if there is a “materially lower” recovery or greater risk in connection with the proposed distribution to the dissenting class, there is a presumption of unfair discrimination; and (8) the presumption of discrimination is rebuttable.

Applying these principles to the case at hand, the Third Circuit found that the bankruptcy court did not err when it compared the Senior Noteholders’ recovery under the plan as against what the Senior Noteholders and the swap claimants would have received if only they were to benefit from the subordination. Although the Senior Noteholders argued that the bankruptcy court should have compared their own recovery absent subordination (21.9%) to the recovery of the trade creditors under the plan (33.6%) who were unfairly favored by the plan, the court ruled that there was no per se requirement that the bankruptcy must compare discrimination as between classes. Accordingly, although the court noted that the bankruptcy court’s analysis in this case was “not the preferred way to test whether the allocation of subordinated amounts under a plan to initially non-benefitted creditors unfairly discriminates,” the court found the minimal impact of the reallocation to the Senior Noteholders’ recoveries—0.90% as measured by the bankruptcy court—was not material and, thus, did not unfairly discriminate. The court went further to emphasize that the unfair discrimination analysis “exemplifies the Code’s tendency to replace stringent requirements with more flexible tests that increase the likelihood that a plan can be negotiated and confirmed.”

Wells Fargo, N.A. v. Bear Stearns & Co., Inc. (In re HomeBanc Mortg. Corp.), 945 F.3d 801 (3d Cir. 2019). The Third Circuit provided clarity on certain issues in a contentious bankruptcy litigation matter involving certain securities subject to one of two repurchase agreements. The decision covers the gamut, running from the good faith of the non-debtor repurchase counterparty in holding an auction for the subject securities to which statutory safe harbor afforded the counterparty the right to liquidate the securities at issue to simple matters of contractual compliance.

Debtor HomeBanc Corp. (“HomeBanc”), who was in the business of originating, securitizing, and servicing residential mortgage loans, obtained financing from Bear Stearns & Co. and Bear Stearns International Ltd. (together, “Bear Stearns”) pursuant to two repurchase agreements (“repos”) between 2005 and 2007. The repos required Bear Stearns to reach a “reasonable opinion” of the fair market value of the securities outstanding in the event of HomeBanc’s default

On August 7, 2007, certain of HomeBanc’s repo transaction became due, requiring HomeBanc to buy back thirty-seven outstanding securities at an aggregate price of $64 million. Bear Stearns, concerned about HomeBanc’s liquidity, offered two alternative solutions to HomeBanc: (1) extend the repurchase deadline in exchange for roughly $27 million, or (2) purchase thirty-six of the securities outright for $60.5 million. HomeBanc rejected both proposals and failed to repurchase the securities by the due date. Bear Stearns notified HomeBanc of the default the next day. Thereafter, on August 9, 2007, HomeBanc filed voluntary petitions for relief under Chapter 11.

Bear Stearns, claiming outright ownership of the securities, decided to auction them to determine their fair market value. The auction was managed by Bear Stearns’ finance desk. Bid solicitations were sent to approximately 200 different entities, including, subject to additional safeguards to prevent any insider advantage, Bear Stearns’ own mortgage trading desk. Only two bids were received: (i) one bid for two securities in the amount of approximately $2.2 million and, (ii) an “all or nothing” bid by Bear Stearns’ mortgage trading desk for $60.5 million. Bear Stearns was declared the winning bid and the purchase price was allocated across the thirty-six purchased securities: $52.4 million for twenty-seven securities and $900,000 each for the nine securities at issue.

After HomeBanc’s bankruptcy was converted to a Chapter 7, years of litigation ensued between Bear Stearns and the trustee, primarily regarding Bear Stearns entitlement to auction the securities as well as the conduct of the auction as a measure of fair market value. Ultimately, these litigations reached the Third Circuit.

Two principal questions came before the Third Circuit as part of this appeal: (1) whether section 559 or section 562 controlled in determining whether Bear Stearns violated the automatic stay; and (2) whether the bankruptcy court correctly concluded that the Bear Stearns auction was conducted in good faith to ascertain fair market value of the securities.

The HomeBanc trustee first challenged whether the safe harbor provision of section 559 or section 562 applied to Bear Stearns. Section 559 applies broadly to repurchase agreements, while section 562 is more limited, requiring proof of damages. Looking to section 101(47)(A)(v)’s definition of repurchase agreement, the court held that “damages” encompasses legal claims for money. Accordingly, because Bear Stearns did not initiate a damages action, section 559 was the relevant safe harbor, notwithstanding that the auction did not yield any excess proceeds.

The court then considered whether Bear Stearns adhered to the liquidation provisions of the repos, as required under section 559. The bankruptcy court had found that Bear Stearns valued the securities at issue in good faith compliance with the relevant repo after a six-day trial, overruling several arguments from the trustee. First, the bankruptcy court rejected the trustee’s claim that the repos required Bear Stearns to sell the securities to an outside party. Second, the bankruptcy court rejected the trustee’s claims that the market for mortgage-backed securities in August 2007 was dysfunctional, such that it would not accurately price the securities. On this point, the bankruptcy court held explicitly that the market was sufficiently function to conduct an auction as required by the repo. The Third Circuit noted that the trustee overlook the crucial distinction between a declining market and a dysfunctional one. Finally, the bankruptcy court concluded that auction procedures were not flawed. The Third Circuit refused to disturb any of the bankruptcy court’s findings since the trustee failed to show that the bankruptcy court had clearly erred.

In re Wilton Armetale, Inc., No. 19-2907 (3d Cir. Aug. 4, 2020). The Third Circuit ruled that a Chapter 7 trustee may restore creditors’ statutory standing to pursue a cause of action that became property of the debtor’s estate by explicitly abandoning such causes of action.

When debtor Wilton Armetale, Inc. (“Wilton”) failed to pay creditor Artesanias Hacienda Real S.A. de C.V. (“Artesanias”) for the purchase of their wares, Artesanias obtained a judgement against Wilton for approximately $900,000 and all the owner’s shares in Wilton. As a consequence of recovering all of the shares in Wilton, Artesanias obtained access to privileged documents held by Wilton’s law firm. From these documents, Artesanias learned not only that Wilton was insolvent, but also that its previous owner and North Mill Capital, another creditor, had plotted with the law firm to plunder Wilton’s remaining assets. After discovering the scheme, Artesanias sued North Mill and the law firm, seeking damages and an order stopping North Mill, who had obtained a lien on Wilton’s valuable warehouse, from foreclosing on the property. Two months after Artesanias brought the suit, Wilton filed for Chapter 7 bankruptcy and a trustee was appointed to liquidate Wilton’s remaining assets.

At the same time, Artesanias’s claim against North Mill and law firm continued in District Court. However, the District Court declined to rule on defendants’ motion to dismiss and instead referred the whole action to the bankruptcy court handling Wilton’s liquidation. On referral, the bankruptcy court found that Artesanias lacked standing to sue because, once Wilton declared bankruptcy, the claims became property of the estate and, therefore, only the trustee had standing to sue on Wilton’s behalf. Artesanias appealed and the District Court affirmed the Bankruptcy Court’s dismissal of the claims for lack of standing.

Applying the Supreme Court’s decision in Lexmark Int’l, Inc. v. Static Control Components, Inc., 572 U.S. 118, 125-28 & n.4 (2014), which distinguished between constitutional standing and additional statutory requirements that may be imposed, the Third Circuit reversed the District Court’s decision. It held that “standing,” as used in the bankruptcy context, imposes additional requirements on litigants that exceed the three elements of constitutional standing required under Article III. In so doing, the Third Circuit court adopted the Seventh Circuit’s interpretation of the term, clarifying that “standing to pursue causes of action that become the estate’s property means its statutory authority under the Bankruptcy Code, not its constitutional standing to invoke the federal judicial power.” Based on this distinction, the Third Circuit determined that the bankruptcy proceedings did not divest Artesanias of its constitutional standing, but rather only its statutory standing to pursue the claims that were property of the Wilton bankruptcy estate, and committed to the purview of the Chapter 7 trustee. However, the court determined that the trustee explicitly abandoned the right to pursue the claims against North Mill and the law firm pursuant to an order of the bankruptcy court. Accordingly, Artesinias’ standing to pursue its initial causes of action was restored by the trustee’s actions. The court further noted that the instant decision was consistent its prior decision in Official Comm. of Unsecured Creditors of Cybergenics Corp. ex rel. Cybergenics Corp. v. Chinery (In re Cybergenics Corp.), 226 F.3d 237, 244-45 (3d Cir. 2000), which the district court had relied on in its holding that the trustee could not transfer a cause of action because Artesinias’ suit would benefit only itself and not the entire creditor body. Thus, when a creditor pursues an asset recovery action prepetition, the trustee may restore the cause of action to that creditor, for its own benefit, rather than the benefit of all creditors, by abandoning the claim.

§ 1.1.5 Fourth Circuit

Ayers v. U.S. Dep’t of Def., No. 19-2230 (4th Cir. Sept. 20, 2020). Adding greater clarity to the corpus of case surrounding the question of appellate jurisdiction of bankruptcy court orders, the Fourth Circuit has held that bankruptcy court orders that do not completely dispose of adversary proceedings are not appealable. An individual debtor brought an adversary proceeding against one of her creditors, the United States Department of Defense. The bankruptcy court dismissed all but one of her claims challenging her debt and denied her motion to amend all but one claim—her request for an undue hardship discharge pursuant to 11 U.S.C. § 523(a)(8). The Fourth Circuit held that the bankruptcy court’s order was not a final, appealable order because the “discrete dispute” was the adversary proceeding itself, notwithstanding that the bankruptcy court’s order conclusively disposed of all but one of the debtor’s causes of action. Because one cause of action remained viable, subject to amendment of the complaint, the Fourth Circuit held that it did not have jurisdiction to review the bankruptcy court’s order dismissing the other claims.

In re Highland Construction Management Services, L.P., No. 18-2450 (March 30, 2020). Affirming the decisions of the U.S. Bankruptcy Court and District Court for the Eastern District of Virginia, the Fourth Circuit Court of Appeals agreed that a security interest in the debtor’s membership interest in an unrelated LLC could only extend to the debtor’s own property interest, and did not encompass the debtor’s economic interest in the unrelated LLC through the debtor’s subsidiary’s separate interest in the same LLC.

Prior to declaring bankruptcy, debtor Highland Construction Management Services, LP (“Highland Construction”) entered into a security agreement in favor of Creditor Wells Fargo Bank, for the benefit of Jerome Guyant IRA (“Guyant IRA”). The security agreement assigned fifty percent of Highland Construction’s membership interest in Sanford, LLC to Guyant IRA. Since Highland Construction had a twenty percent membership interest in Sanford, Highland Construction argued in the bankruptcy proceeding that the agreement assigned to Guyant IRA a ten percent membership interest in Sanford. Creditor Guyant IRA interpreted the scope of the security agreement differently and contended that, rather than assigning half of its twenty percent membership interest in Sanford LLC, Highland Construction assigned to Guyant IRA sixteen percent of all funds it received from distributions from Sanford. Guyant IRA argued that it was owed the extra six percent based on debtor Highland Construction’s interest in a second LLC, named Foothills, LLC. Highland Construction had a fifty percent membership interest in Foothills, LLC, which had its own twenty-four percent interest in Sanford. Guyant IRA argued that Highland Construction’s fifty percent interest in Foothills meant that Highland Construction received an additional twelve percent distribution from Sanford through Foothills, and, therefore, Guyant IRA had a fifty percent interest in Highland Construction’s indirectly held twelve percent interest of Sanford, in addition to the twenty percent that Highland Construction held directly. However, Foothills, LLC was not named in the security agreement. Notwithstanding that the recitals of a 2008 amendment to the security agreement between Highland Construction and Guyant IRA referred to a sixteen percent interest in Sanford,the Bankruptcy Court agreed with the debtor Highland Construction, holding that Highland Construction only owed Guyant IRA fifty percent of its directly held membership interest in Sanford, LLC—i.e., ten percent. The District Court affirmed without issuing a written opinion.

The Fourth Circuit affirmed the decision, explaining that Virginia corporations law would only ever allow Highland Construction to assign a portion of its own property; therefore, Highland Construction could not have assigned any portion of Foothills’ property, including its interest in Sanford, LLC. Since Highland Construction could not have assigned Foothills’ membership interest in Sanford in the security agreement, the fifty percent membership interest assignment in the security agreement could only be Highland Construction’s twenty percent direct membership interest in Sanford, LLC. Therefore, the Bankruptcy Court had correctly interpreted the scope of the security interest.

§ 1.1.6 Fifth Circuit

In re DeBerry (Whitlock L.L.C. v. Lowe), 945 F.3d. 943 (5th Cir. 2019). The debtor’s wife opened a joint bank account with her sister-in-law, Ms. Whitlock. The joint bank account was funded with a cashier’s check for $275,000.00 that had been withdrawn from a joint marital account. Three days after opening the account, the debtor’s wife removed herself from the newly opened joint account, leaving it solely in Ms. Whitlock’s name. One month later, the $275,000.00 was transferred out of the account in a series of transactions. Two wire transfers were at the heart of the case. Ms. Whitlock signed these wire transfers at the debtor’s wife’s request and had no knowledge regarding the transfers. The trustee commenced an adversary proceeding against the sister-in-law to recover a total of $275,000.00 in fraudulent transfers. Following the settlement with the debtor’s daughter, $241,500.00 was at issue. The trustee argued that Ms. Whitlock was liable for the entire amount pursuant to Section 550 of the Bankruptcy Code, which allows a bankruptcy trustee to recover fraudulently transferred funds from transferees. Ms. Whitlock contended that she was not a “transferee” because the money never belonged to her and that she was a mere conduit. Second, Ms. Whitlock argued that the funds had already been returned to the debtors via the wire transfers, so they could not be recovered.

The bankruptcy court held that, as Ms. Whitlock was the sole owner of the bank account, she was the initial transferee of an avoidable transfer subject to recovery under Section 550(a)(1). Although the Bankruptcy Code provides that the trustee is “entitled to only a single satisfaction” for avoided transfers, 11 U.S.C. § 550(a) & (d), the bankruptcy court took the view that the single-satisfaction rule does not apply to funds that were returned to the debtor prior to the petition date. Accordingly, the bankruptcy court entered judgment for the trustee. The question for the Fifth Circuit was whether the trustee can recover funds that were already returned to the debtor. The court began by noting that Section 550(a) permits the trustee to “recover” the property. The court found that obtaining a duplicate of something is not getting it back, which is the definition of “recover,” but that it would be a windfall. Property that has already been returned simply cannot be recovered.

Every other court to consider this issue has agreed with the foregoing plain reading of the text. Some courts cite Section 550(d)’s ‘satisfaction rule’ and others rely on the bankruptcy court’s equitable powers. The trustee could not point to a single decision supporting his reading of Section 550, but raised four arguments in opposition to the uniform interpretation of Section 550. The trustee’s primary argument was that a plain reading of Section 550(d) means the single satisfaction rule does not extend to a prepetition reconveyance directly to the debtor. Instead, the trustee argued that the single-satisfaction rule only applies to a satisfaction pursuant to Section 550(a), which a prepetition transfer could not be. The court rejected “this strained reading.” Looking to the plain meaning of the word “satisfaction,” the court held that, if an obligation has already been satisfied, the transferee has no further obligation. That is “the trustee’s ‘avoidance action was satisfied before it was ever commenced.’” Second, the trustee argued that nothing in the legislative history suggested that Congress intended Section 550(d) to be triggered by a prepetition repayment to the debtor. The court noted that legislative history is not the law. However, even assuming that the legislative history was relevant in general, it found the particular bit of legislative history cited by the trustee to be irrelevant. Third, the trustee argued that, because the bankruptcy estate does not exist until the petition is filed, a prepetition satisfaction does not count as recovery “for the benefit of the estate.” The court rejected this argument because it did not hold that the return of the property constituted a recovery for the benefit of the estate under Section 550(a), but instead held that there cannot be a recovery at all if the property has already been returned. Fourth, and finally, the trustee argued that the bankruptcy court cases rejecting his reading were distinguishable because they actually involved a windfall to the bankruptcy estate. The trustee argued that the recovery in this case could not provide a windfall to the estate because it did not remain in the estate at the time of the petition. The Fifth Circuit noted that the bankruptcy code does not give the trustee the power to review for reasonableness the debtor’s prepetition expenditures. Whether the debtor frittered away the money or not was simply irrelevant to the case. Accordingly, the judgment was reversed.

In re Willis (Tower Loan of Mississippi, L.L.C. v. Willis), 944 F.3d. 577 (5th Cir. 2019). The debtor commenced an adversary proceeding pursuant to the Truth in Lending Act. The lender moved to dismiss or, in the alternative, to compel arbitration. The bankruptcy court denied the motion and the district court affirmed. On appeal, the Fifth Circuit began by focusing on the agreement signed by the debtor when he borrowed money from the lender. The court noted that “in signing the loan agreement, [the debtor] agreed to an arbitration agreement found on its back side.” Similarly, in an insurance policy purchased in connection with the loan, the debtor agreed to a second arbitration agreement. The lender did not sign the second agreement, but its representative handed it to the debtor for his signature. The two arbitration agreements were similar but not identical. Both broadly required arbitration for all disputes, including for any arising pursuant to the loan or the insurance policies. Further, both agreements gave the arbitrator the power to decide gateway arbitrability. The agreements, however, conflicted with respect to several procedural aspects of arbitration: e.g., selection and number of arbitrators, time to respond, location, and fee shifting.

In denying the lender’s motion, the bankruptcy court held that the first and second arbitration agreements formed a single contract and the conflicting provisions meant that the debtor and the lender had not formed a sufficiently definite contract to arbitrate under state law. The court began its analysis with state law to determine whether the parties formed an arbitration agreement at all. If so, the court would interpret the contract to determine whether the claim at issue was covered by the agreement. This second step is normally for the court, but this analysis changes where the agreement delegates that question to the arbitrator.

The Fifth Circuit, applying Mississippi law, agreed with the lower courts that the two agreements constituted a single contract. However, the Fifth Circuit disagreed with the bankruptcy court’s holding that conflicts between the two agreements prevented a meeting of the minds. The court found that, notwithstanding these conflicts, the parties’ intention was unmistakable: “They wished to arbitrate any dispute that might arise between them.” The conflicting terms were not essential and, as a matter of Mississippi law, the parties validly contracted to arbitrate. Turning to whether the claim was arbitrable, the court found that there was clear intent to have the arbitrator decide the issue. Accordingly, it was for the arbitrator to decide whether the Truth in Lending Act claim was subject to arbitration and to resolve the inconsistent procedural terms. The court reversed and remanded to the district court with directions to refer the dispute to arbitration.

In re Sherwin Alumina Co. (Port of Corpus Christi Auth. v. Sherwin Alumina Co.), 952 F.3d. 229 (5th Cir. 2020). The Port of Corpus Christi Authority owned an 1,100-acre parcel of land adjacent to land owned by the debtor. The Port also held an easement granting use of and access to a private road on the debtor’s land, which provided the primary means of commercial access to the Port’s land. The debtor sought Chapter 11 relief from the United States Bankruptcy Court for the Southern District of Texas and filed its initial joint plan for reorganization. In that plan, the debtor proposed to sell its real property free and clear of all liens, claims, charges, and other encumbrances in accordance with Section 363(f) of the Bankruptcy Code. In accordance with bankruptcy court-approved bidding procedures, an auction was held and a third party emerged as the successful bidder. Over the subsequent months, the debtor filed various modified plans and purchase agreements. In each such document, it was clear that encumbrances other than those deemed permitted would be stripped off the estate’s property in accordance with Section 363(f). Although permitted encumbrances were to be defined in a future proposed confirmation order, no document ever suggested that the Port’s easement would be a permitted encumbrance.

On the day of the confirmation hearing, the debtor filed a proposed confirmation order that defined permitted encumbrances to include a number of specific servitudes, easements and encumbrances, but the Port’s easement was not included. The Port was served with that proposed confirmation order. At the confirmation hearing that day, debtor’s counsel stated that the proposed order had been submitted with extensive modifications but he did not believe those modifications were material. The bankruptcy court entered the order without objection and the plan was confirmed.

More than a month after confirmation, a subsequent owner of the debtor’s property notified the Port that its easement had been extinguished by the sale of the land pursuant to the plan. Because the time to appeal the confirmation order had expired, the Port commenced an adversary proceeding to collaterally attack the confirmation order as having been procured by fraud, obtained via a denial of due process for want of notice, and as having barred by sovereign immunity. The bankruptcy court dismissed the claims of fraud and sovereign immunity without leave to amend but failed to dismiss the due process claim. The Fifth Circuit considered the Port’s appeal of the dismissal.

With respect to the question of sovereign immunity, the court looked to the United States Supreme Court’s decision in Tennessee Student Assistance Corporation v. Hood, which held that “a bankruptcy court’s discharge of an individual’s debt to the state of Tennessee did not violate the Eleventh Amendment.” In that decision, the Supreme Court found that a discharge proceeding was an exercise of the bankruptcy court’s in rem jurisdiction over the debtor’s estate; that the debtor did not seek affirmative relief against the state; and that the proceeding did not subject the state to any coercive judicial process. Accordingly, the Eleventh Amendment was not violated. The Fifth Circuit reached a similar conclusion in connection with the Port’s appeal. The court noted that the servient land was part of the bankruptcy estate and that the Port’s easement was “a non-possessory property interest” in that land. Because the bankruptcy court’s order authorizing the sale free and clear of the Port’s interest neither awarded affirmative relief nor deployed coercive judicial process, the bankruptcy court was not exercising in personam jurisdiction over the state. The court found that the Port’s easement was similar to Tennessee’s debt in the Hood case. The Port held an interest burdening the bankruptcy res. Moreover, the bankruptcy court properly exercised its in rem jurisdiction over the estate to extinguish that burdensome interest.

The court noted that it was not considering whether the proposed sale met the requirements for a sale free and clear pursuant to Section 363(f). That argument was foreclosed because it had not been raised on direct appeal and could not be raised in a collateral attack.

The court then turned to Section 1144 of the Bankruptcy Code, which provides “[o]n request of a party in interest at any time before 180 days after the date of entry of the order of confirmation, and after notice and a hearing, the court may revoke such order if and only if such order was procured by fraud.” The appellate court rejected the Port’s Section 1144 claim because it failed to allege any intentional false representation. In reviewing the record, the court of appeals noted that from the initial bankruptcy filing until the confirmation hearing, more than a year later, the debtor had always proposed a sale in which property of the estate would be sold free and clear of all liens, claims, charges, and other encumbrances. The court noted that under Texas law an easement is a type of encumbrance. While the last-minute submission of the proposed confirmation order did carve out certain encumbrances from the sale order, there were not any changes at all with respect to the Port’s easement. Accordingly, the court affirmed the dismissal of the Port’s Eleventh Amendment and fraud claims, but noted that the due process claim was still pending before the bankruptcy court and that it was not addressed.

In re Hidalgo County Emergency Services Found. (Hidalgo County Emergency Services Found. v. Carranza), 962 F.3d. 838 (5th Cir. 2020). Congress responded to the coronavirus pandemic by enacting the Coronavirus Aid Relief and Economic Security Act (the “CARES Act”). Among other things, the CARES Act made available government-guaranteed loans to qualified small businesses through the Paycheck Protection Program (“PPP”). The PPP is administered by the Small Business Administration (“SBA”). The SBA promulgated regulations concerning PPP eligibility. One of those regulations provided that a debtor in a bankruptcy proceeding would be ineligible to receive a PPP loan. A Chapter 11 debtor alleged that it was denied a PPP loan based on its status as a bankruptcy debtor and filed an adversary proceeding against the SBA. The debtor contended that the SBA’s decision to preclude bankrupt parties from obtaining PPP loans violated Section 525(a) of the Bankruptcy Code which prohibits discrimination based on bankruptcy status and was arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law, and finally that it was in excess of the statutory jurisdiction granted to the SBA. The bankruptcy judge agreed with the debtor and issued a permanent injunction mandating that the SBA handle the debtor’s PPP application without consideration of its ongoing bankruptcy. The case was certified for direct appeal to the United States Court of Appeals for the Fifth Circuit. On appeal, the SBA Administrator argued that the Small Business Act prohibited injunctive relief against his office. 15 U.S.C. § 634(b)(1). The Fifth Circuit had previously held “that all injunctive relief directed at the SBA is absolutely prohibited.” The court noted that the “issue at hand is not the validity or wisdom of the PPP regulations and related statutes, but the ability of a court to enjoin the administrator, whether in regard to the PPP or any other circumstance.” The court held that “under well-established Fifth Circuit law, the bankruptcy court exceeded its authority when it issued an injunction against the SBA Administrator.” Accordingly, the preliminary injunction was vacated.

In re Ultra Petroleum Corp. (Three Rivers Holdings, L.L.C. v. Ad Hoc Committee of Unsecured Creditors of Ultra Resources, Incorporated), 943 F.3d. 758 (5th Cir. 20219). In this case, the Fifth Circuit addressed what it considered “exceedingly anomalous facts.” Those anomalous facts were that the debtor entered its bankruptcy proceeding insolvent, but then became solvent. These unique facts arose “by virtue of a lottery-like rise in commodity prices.” As a result, “the debtors proposed a rare creature in bankruptcy—a reorganization plan that (they said) would compensate their creditors in full.” With respect to certain unsecured notes, the debtors proposed to pay three sums: “the outstanding principal on those obligations, pre-petition interest at a rate of 0.1%, and post-petition interest at the federal judgment rate.” Based on this treatment, the debtors’ plan treated this class of creditors as unimpaired, who could, therefore, not object to the plan. Notwithstanding their designation as unimpaired, the class of creditors objected insisting that they were impaired because the plan did not provide for payment of a contractual make-whole premium and additional post-petition interest at contractual default rates. The make-whole premium was triggered upon prepayment and was designed to provide compensation for the noteholder’s right to maintain its investment free from repayment. The relevant loan agreements provided that a bankruptcy petition made the outstanding principal, any accrued interest, and the make-whole amount immediately due and payable. The debtors acknowledged that their plan did not call for payment of the make-whole amount or provide post-petition interest at the contractual rates. They nonetheless insisted that the creditors were not impaired because federal law barred them from recovering the make-whole premium and entitled them to receive post-petition interest only at the federal judgment rate.

The Fifth Circuit began its analysis by noting that the Bankruptcy Code “provides that a class of claims is not impaired if ‘the [reorganization] plan … leaves unaltered the legal, equitable, and contractual rights to which such claim … entitles the holder.” The court noted section 502(b)(2) of the Code requires a court to disallow a claim to the extent it seeks unmatured interest. The debtors argued that the make-whole amount qualified as unmatured interest. They also argued that it was an unenforceable liquidated damages provision under New York law. As a result, something other than the plan, either the Bankruptcy Code or New York law, prevented this class of creditors from recovering the disputed amount. The debtors made a similar argument with respect to post-petition interest. Section 726(a)(5) of the Code entitles creditors at most, to post-petition interest at the legal rate, and not the contract rate. The bankruptcy court rejected these arguments. It held that New York law permitted recovery of the make-whole premium and imposed no limit on contractual post-petition interest rates. The Fifth Circuit noted that the bankruptcy court did not address whether the Bankruptcy Code disallowed the make-whole amount as unmatured interest or what section 726(a)(5)’s “legal rate” of interest means. Based on these holdings, the bankruptcy court ordered the debtors to pay the make-whole premium and post-petition interest at the contractual rate. The question was certified for direct appeal to the Fifth Circuit.

The appellate court found that the plain text of section 1124(1) requires that the alteration of the creditor’s rights be as a result of a plan and not otherwise, in order for that creditor to be impaired. It held that “a creditor is impaired under [section] 1124(1) only if ‘the plan’ itself alters a claimant’s ‘legal, equitable, [or] contractual rights.’” The court noted that the creditors could not point to a single decision suggesting otherwise. To the contrary, the court noted that Collier on Bankruptcy “states the point in unequivocal terms: ‘Alteration of Rights by the Code Is Not Impairment under Section 1124(1).’” The court, therefore, concluded that, when “a plan refuses to pay funds disallowed by the Code, the Code—not the plan—is doing the impairing.” The court then turned to the question of whether the Bankruptcy Code disallowed the claims for the make-whole amount and post-petition interest at the contractual rate. The creditors argued that their contract should be honored “under bankruptcy law’s long-standing ‘solvent-debtor’ exception.” The debtors argued that no such exception exists under the Bankruptcy Code. The Bankruptcy Court had never reached these questions. The Fifth Circuit noted that the issue of make-whole premiums had become a common issue in modern bankruptcy. While the court cited cases holding that it was sometimes very easy to tell whether such premiums were effectively unmatured interest that was disallowed by section 502(b), it also cited cases finding that it can be a harder question depending “on the dynamics of the individual case.” The court noted that the bankruptcy court would be best equipped to address this question and the question of post-petition interest. The court noted that its review of the record revealed no reason why the solvent-debtor exception could not apply in applying that exception. Moreover, other circuits had held that “absent compelling equitable considerations, when a debtor is solvent, it is the role of the bankruptcy court to enforce the creditors’ contractual rights.” The appellate court, therefore, remanded the matter to the bankruptcy court.

§ 1.1.7 Sixth Circuit

Fed. Energy Reg. Comm’sn v. First Energy Sols. Corp. (In re First Energy Sols. Corp.), 945 F.3d 431 (6th Cir. 2019). In a ruling at the intersection of energy law and bankruptcy, the Sixth Circuit held that (i) energy contracts do not amount to de jure regulations in the context of bankruptcy, and are, thus, capable of rejection; (ii) bankruptcy courts do not have unfettered jurisdiction superior to that of the Federal Energy Regulatory Commission (“FERC”), although the bankruptcy court may enjoin FERC from acting in circumstances where FERC might seek to directly interfere with a bankruptcy proceeding; and (iii) rejection of energy contracts should be governed by a standard that scrutinizes the impact of rejection on the public interest—something more than ordinary business judgment—aligning itself with the Fifth Circuit.

FirstEnergy Solutions Corp. (“FirstEnergy”) and its subsidiary commenced Chapter 11 proceedings in March 2018. The day after it commenced bankruptcy proceedings, it filed an adversary proceeding against FERC seeking a declaratory judgment that the bankruptcy court’s jurisdiction was superior to FERC’s and injunctions prohibiting FERC from interfering with FirstEnergy’s intended rejection of certain energy contracts that it had previously filed with FERC. The bankruptcy issued broad injunctions against FERC, prohibiting it from taking any action with respect to FirstEnergy.

The first question the court addressed was whether contracts filed with FERC cease to be ordinary contracts once they are filed, and instead become de jure regulations, which should not be subject to rejection in bankruptcy. Considering the public necessity of federal regulation of the energy alongside the public necessity of ensuring the ability of energy companies to survive, even when burdened with unprofitable contract, the court determined that “the public necessity of available and functional bankruptcy relief is generally superior to the necessity of FERC’s having complete or exclusive authority to regulate energy contracts and markets.” Thus, for bankruptcy purposes, the subject contracts were not de jure regulations beyond the ambit of rejection under the Bankruptcy Code.

The second question that the court addressed was whether the bankruptcy court was entitled to enjoin FERC “from doing anything and everything—from entering any orders or even holding its own hearing.” Id. at 448 (emphasis original). The Sixth Circuit held that the bankruptcy court’s order strayed too far from precedent established under Chao v. Hospital Staffing Services, 270 F.3d 374 (6th Cir. 2001). Although the Circuit Court did not necessarily disagree with the bankruptcy court’s holding that FERC proceedings were not excepted from the automatic stay under the public-policy test, it concluded that the bankruptcy court was wrong not to limit its holdings to the facts at hand (the bankruptcy court’s holding would have held that FERC’s interest in preventing bankruptcy rejection of any filed contract would be only incidentally public, and, thus, would always be subject to the automatic stay). The Sixth Circuit further noted that the bankruptcy court improperly omitted a crucial point in Chao—that any conflict in jurisdiction should be decided by an appellate court with jurisdiction to hear appeals from both fora.

The Sixth Circuit further held that section 105(a) of the Bankruptcy Code did not provide the bankruptcy court with unfettered power to enjoin FERC. Instead, relying heavily on the Fifth Circuit’s interpretation of a similar question in In re Mirant Corporation, 378 F.3d 511 (5th Cir. 2004), the Sixth Court held that section 105(a) afforded the bankruptcy court only the power to enjoin FERC from issuing potentially contradictory orders. Because the bankruptcy court’s injunction prohibited FERC from taking any action whatsoever, even so far as holdings its own hearing, it went too far. Thus, the court concluded that the bankruptcy court has jurisdiction superior to FERC in matters which might interfere with the bankruptcy proceeding, but does not have the unfettered right to enjoin FERC from “risking its own jurisdictional decision, conducting its (otherwise regulatory mandated) business, or issuing orders that do not interfere with the bankruptcy court.”

Finally, the Sixth Circuit decided the standard applicable to rejection of a FERC-regulated contract. Relying on the standard established by the Fifth Circuit in Mirant, the court determined that the bankruptcy court must consider rejection of executory power contract in the context of the public interest, including the consequential impact on consumers and any tangential contract provisions concerning, for instance, decommissioning, environmental management, and future pension obligations, to ensure that “the equities balance in favor of rejecting the contracts.” Id. at 454 (citing Mirant, 378 F.3d at 525).

§ 1.1.8 Seventh Circuit

In re hhgregg, Inc., 949 F.3d 1039, 1041 (7th Cir. 2020). In a priority contest between a supplier seeking reclamation of inventory provided to the debtor and the debtor’s secured DIP lender with a floating lien on all of the debtor’s assets, including existing and after-acquired inventory and its proceeds, the Seventh Circuit Court of Appeals held that the secured lender’s interest in the inventory is superior to the supplier’s pursuant to section 546(c) of the Bankruptcy Code.

The debtor hhgregg, Inc. (the “Debtor”), which sold home appliances, electronics and related services to consumers, filed for Chapter 11 bankruptcy. A prepetition lender, Wells Fargo Bank (“Wells Fargo”), became a DIP lender with the bankruptcy court’s approval, and obtained a priming, first-priority floating lien on substantially all of the Debtor’s assets, including existing and after-acquired inventory and its proceeds. Subsequently, one of the Debtor’s suppliers, Whirlpool, sent a reclamation demand seeking the return of appliances it had delivered in the 45-day period before the bankruptcy petition.

Whirlpool then filed an adversary action against Wells Fargo seeking a declaration that its reclamation claim was first in priority as to the reclaimed goods, alleging, among other things, that Wells Fargo had not acted in good faith because it knew the Debtor was insolvent and still continued to provide financing, enabling the Debtor to acquire additional inventory from suppliers like Whirlpool in order to expand Wells Fargo’s own collateral base. Wells Fargo moved to dismiss. The bankruptcy judge treated the motion as one for summary judgment and entered final judgment for Wells Fargo. The judge noted that the 2005 amendments to the Bankruptcy Code, which resulted in the current form of section 546(c), expressly made a seller’s reclamation right “subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof,” and held that Whirlpool’s reclamation claim was subordinate to Wells Fargo’s prior, unbroken lien chain on the Debtor’s assets. The district court affirmed.

The Seventh Circuit Court of Appeals also affirmed. The court held that a reclamation claim was governed by 11 U.S.C. § 546(c), as modified by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which provides that a seller’s right to reclaim goods is “subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof.” The court examined the history of section 546(c), noting that although priority was uncertain under the old version of section 546(c), the 2005 amendments made it “crystal clear that a seller’s reclamation claim is subordinate to ‘the prior rights of a holder of a security interest.’ [11 U.S.C.] § 546(c)(1). What this means as a practical matter is that ‘if the value of any given reclaiming supplier’s goods does not exceed the amount of debt secured by the prior lien, that reclamation claim is valueless.’” In re hhgregg, Inc., 949 F.3d 1039, 1048 (7th Cir. 2020) (quoting In re Dana Corp., 367 B.R. 409, 419 (Bankr. S.D.N.Y. 2007)).

The court found that, under the terms of the DIP financing agreement and effective upon entry of the court’s interim DIP financing order, Wells Fargo obtained a perfected, first-priority security interest in all hhgregg assets, including the reclaimed goods, and it maintained a continuous lien chain that preceded Whirlpool’s reclamation demand. Specifically, the court rejected Whirlpool’s argument that its reclamation claim was “in effect” as of the March 6 petition date and “jumped into first position” during a “gap in the lien chain” that occurred between March 6, when Wells Fargo’s prepetition security interest was superior, and March 7, when Wells Fargo’s postpetition security interest attached pursuant to the DIP financing order, finding that Whirlpool had no right under section 546(c)(1) until it served its written reclamation demand on March 10.

The court further dismissed Whirlpool’s arguments referring back to state law principles as explicitly overridden by the adoption of the federal priority rule implemented pursuant to section 546(c).

§ 1.1.9 Eighth Circuit

In re Peabody Energy Corporation, No. 19-1767 (8th Cir. May 6, 2020). The Eighth Circuit curtailed the ability of municipalities to make public nuisance-type claims against companies that have emerged from bankruptcy, when the behavior giving rise to the claim is abated prepetition. The court affirmed decisions of the U.S. Bankruptcy Court and the U.S. District Court for the Eastern District of Missouri, finding that the plaintiff municipalities were barred from asserting claims for “contributions for global warming” from the debtor’s export of coal from California.

In April 2016, Peabody Energy Corporation (“Peabody”) filed for Chapter 11 bankruptcy. Ultimately, Peabody emerged from bankruptcy as a reorganized company. Several months after Peabody emerged from bankruptcy, three California municipalities sued it—along with over thirty other energy companies—alleging claims of negligence, strict liability, trespass, private nuisance and public nuisance for the defendants’ former and ongoing contributions to global warming. The public nuisance claims sought, among other things, damages and disgorgement of profits. In response, Peabody moved the bankruptcy court to enjoin the municipalities from pursuing their claims and dismiss them with prejudice on the ground that the court-approved plan of reorganization had discharged the claims. The bankruptcy court granted Defendant Peabody’s request, finding that the plaintiffs’ claims focused on acts occurring from 1965 to 2015 (except for Peabody’s continued export of coal from California), and was, therefore, discharged by Peabody’s plan as relating to Peabody’s prepetition conduct.

The Eighth Circuit rejected the municipalities’ arguments on appeal. First, the Eighth Circuit agreed with the bankruptcy court that the municipalities’ common law claims did not qualify as “Environmental Laws,” as defined in Peabody’s plan, that were specifically excepted from discharge. The court then affirmed that the municipalities’ claims were not an exercise of their police power because the municipalities were seeking money as victims of alleged torts, rather than exercising regulatory or police authority over Peabody.

The court also rejected the plaintiffs’ argument that their representative public-nuisance claims were exempt from discharge because the public-nuisance claims, asserted on behalf of the people of California, were not claims under bankruptcy law since California law does not permit them to recover damages under that theory. Rather than relying on the statutory language, which limited recovery on public nuisance claims to an “equitable decree,” the Court probed further, and upon finding that such equitable decrees could include obligations to pay money, found that those claims too were dischargeable in bankruptcy. It did not matter that the municipalities were not requesting this remedy in their complaint; the court found that fact that a California court could order the remedy was sufficient to make the claim dischargeable in bankruptcy. Finally, the court rule that allegations in the complaint extending to Peabody’s postpetition conduct, exporting coal, were insufficient to change the nature of the complaint to one for postpetition conduct.

In re Family Pharmacy, Inc., No. 19-6025, 2020 WL 1291112 (8th Cir. BAP Mar. 19, 2020). The Bankruptcy Appellate Panel for the Eighth Circuit has held that oversecured creditors have an unqualified right to recover interest under section 506(b), and such right is not subject to reconsideration on the basis of enforcement as a penalty under Missouri law, nor is it subject to rebuttal based on equitable considerations.

Between July 2014 and March 2018, the Bank of Missouri (“BOM”) made eight loans in the total amount of approximately $11 million to Family Pharmacy, Inc. and four related entities (the “Debtors”). The debt to BOM was secured by a first priority lien on the Debtors’ assets, consisting primarily of inventory, equipment and real estate used in operating their business. The Debtors’ assets were also encumbered by two other secured creditors: Cardinal Health, who had a second priority lien securing $1 million in debt, and J M Smith Corporation and Smith Management Services, LLC (together, “Smith”), which had a third priority lien securing $18 million in debt.

In April 2018, the Debtors filed for Chapter 11. They subsequently sold their assets at an auction free and clear of all liens in the amount of $13.975 million. The bankruptcy court entered a sale order approving Smith as the purchaser. BOM, as an over secured creditor, later filed a motion under 11 U.S.C. § 506(b) seeking allowance of interest calculated at a high default rate on the basis that it was oversecured. The bankruptcy court denied BOM’s motion, holding that the default rate constituted an unenforceable liquidated damages penalty under Missouri law. The bankruptcy court also held that the default interest rate could not be enforced based on equitable considerations.

On appeal, the Eighth Circuit Bankruptcy Appellate Panel reversed. The Panel began its analysis by acknowledging that all over secured creditors are entitled to postpetition interest. The Panel observed that most courts have concluded that such postpetition interest should be calculated at the rate provided in the contract. It also noted that the parties had agreed that the substantive law of the state of Missouri would apply. Missouri law permits parties to loans to agree in writing to any rate of interest, fees and other terms and conditions.

The Panel pointed out that liquidated damage provisions and default interest provisions are often conflated. However, default interest is not subject to rebuttal if it is construed as a penalty. The analysis is more straightforward—if there has been a default, the default interest rate negotiated by the parties will apply; a liquidated damages provision merely fixes the amount of damages payable in the event of a specified breach. The panel held that the bankruptcy court erred by applying a liquidated damages analysis because doing so imputed a “reasonableness” analysis to the question of BOM’s unqualified right to interest.

The Panel also reversed the bankruptcy court’s ruling that the equities of the case mandated disallowance of the default interest rate, noting that “no section of the Bankruptcy Code gives the bankruptcy court authority, equitable or otherwise, to modify a contractual interest rate prior to plan confirmation.” It concluded that absent some compelling reason to the contrary, BOM should be permitted to collect interest at the higher rate if the bankruptcy court concluded that the default rate applied. The Panel remanded the matter for further proceedings before the bankruptcy court.

§ 1.1.10 Ninth Circuit

In re Gardens Reg’l Hosp. & Med. Ctr., Inc., 975 F.3d 926 (9th Cir. 2020). The Ninth Circuit recently added greater contours to the definition of recoupment versus setoff when it affirmed in part and reversed in part a bankruptcy court determination that the California Department of Health Care Services (the “State”) was entitled to recoup a debtor’s prepetition and postpetition health-related tax assessments from the obligations the State owed to the debtor. The court held that, while one of the State’s obligations running to the debtor bore the necessary logical connection to the assessment to qualify for recoupment, the other stream of payments from the State to the debtor, just by virtue of arising out of the State’s Medicaid program from which the assessment arose, did not.

The State imposed a Hospital Quality Assurance Fee (“HQAF”) on private hospitals that the debtor, Gardens Regional Hospital and Medical Center, Inc. (“Gardens Regional”) failed to pay before filing for bankruptcy. If a hospital failed to pay, the State was authorized by statute to immediately deduct the unpaid assessment from any payments the State owed to the hospital. California’s Medicaid program used a “fee-for-service” system through which a covered individual would receive treatment with a participating hospital and the state would pay the provider for the service. As a result of the fee-for-service system, the State owed certain payments to Gardens Regional. The State also owed Gardens Regional certain “supplemental” payments that resulted from the HQAF scheme. The State recovered the entirety of its prepetition debt arising from the HQAF assessments, as well as a significant portion of HQAF assessments arising postpetition, by withholding portions of the fee-for-service payments as well as the supplemental payments to which Gardens Regional was entitled.

Gardens Regional filed a motion to compel the State to return the amounts, arguing that the withholdings were in violation of the automatic stay and constituted an impermissible setoff. The State maintained that the withholdings were exempt from the automatic stay under the equitable doctrine of recoupment. The bankruptcy court held that the HQAF assessments had a logical relationship to the fee-for-service payments and the supplemental payments, and denied the Gardens Regional’s motion. The BAP affirmed the holding of the bankruptcy court.

Before discussing the case at hand, the Ninth Circuit described the difference between setoff, the exercise of which is subject to the automatic stay, and recoupment, the exercise of which is not subject to the automatic stay. While setoff involves mutual debts and claims these debts and claims could arise from different transactions. Recoupment, on the other hand, involves defining the amount owed under a single claim. However, the rights giving rise to recoupment must also stem from the same transaction or occurrence. The court emphasized that the most important consideration when analyzing a claim for recoupment was whether the claims or rights for which recoupment was sought by the creditor had a “logical relationship” to the obligations owed by the debtor to the creditor.

The Ninth Circuit considered both compensation streams from which the State withheld payment to Gardens Regional. It found there was a direct connection between the HQAF payments, which went to a segregated fund, and the supplemental payments that were made to hospitals from that very same fund. Further, the HQAF statute explicitly detailed that the purpose of the HQAF program was to allow for certain fees to be paid by hospitals, which would then be used to increase federal financial participation which allowed the State to then make supplemental payments back to the hospitals. Gardens Regional argued that federal law actually prohibits any specific linkage between the HQAF assessments of a taxpayer and the amount of Medicaid payments made to that taxpayer however the Court indicated that, while this was true, the HQAF program created an “overall linkage” between the payment systems in and out of the fund which was sufficiently connected as to permit recoupment. However, with regards to the payments owed to the Gardens Regional under the fee-for-service payments, the court found that these deductions were an improper setoff because the same statutory relationship that existed as between the supplemental payments and the HQAF assessments was lacking as between the fee-for-service payments and the HQAF assessments such that the payments lacked any legal or factual connection to the HQAF assessments.

Blixseth v. Credit Suisse, No. 16-35304 (9th Cir. June 11, 2020). Overturning a district court’s dismissal of a challenge to an exculpation provision under a Chapter 11 plan on equitable mootness grounds, the Ninth Circuit nonetheless affirmed the dismissal on its merits. The Court held that section 524(e) did not bar a narrow exculpation provision contained in the plan, notwithstanding that the exculpation barred certain claims against non-debtors for actions related to the plan approval process.

In 2000, Timothy Blixseth (“Blixseth”) and his wife (“Edra”) founded the Yellowstone Club in Big Sky, Montana. In 2005, Blixseth obtained a $375 million loan from Credit Suisse and other lenders, secured by the assets of companies related to the Yellowstone Club (collectively, the “Yellowstone Entities”). When Blixseth and Edra divorced in 2008, Edra became the indirect owner of the Yellowstone Entities. Largely because Blixseth had “mismanaged and misused” the 2005 loan proceeds, which the companies could not afford to pay back, Edra decided to pursue an asset sale through a Chapter 11 proceeding.

The exculpations became a hot button issue as the parties came to the plan negotiation stage of the Chapter 11 proceedings. Credit Suisse objected to confirmation, in part on grounds that the releases then contained in the plan were over-inclusive and, therefore, forbidden in the Ninth Circuit. Eventually, Credit Suisse, the Yellowstone Entities, and the asset purchaser entered into a global settlement, upon which an amended plan was formulated. The amended plan included an exculpation which extended to Credit Suisse, the asset purchaser, and Edra for “any act or omission in connection with, relating to or arising out of the Chapter 11 Cases, the formulation, negotiation, implementation, confirmation or consummation of this Plan, Disclosure Statement, or any contract, instrument, release or other agreement or document entered into during the Chapter 11 Cases or otherwise created in connection with this Plan.” Blixseth, who has not covered by the exculpation, objected to the plan. The bankruptcy court approved the plan over Blixseth’s objection. Blixseth appealed to the district court, which reversed based on the breadth of the exculpation. On remand, the bankruptcy court again confirmed the plan, without modification, holding that the exculpation was “narrow in both scope and time.” Again, Blixseth appealed to the district court. This time, the district court dismissed the appeal for Blixseth’s lack of standing, after rejecting the plan proponents’ argument that the appeal was barred by equitable mootness. The Ninth Circuit revered in part and affirmed in part, holding that Blixseth had standing to pursue the appeal, which was not equitably moot. The Circuit Court remanded to the district court for a determination on the merits of Blixseth’s appeal. However, on remand, the district court did not reach the merits, instead ruling that Blixseth’s appeal was barred by equitable mootness.

After refusing to dismiss Blixseth’s appeal for failing to abide by certain scheduling orders, the Ninth Circuit determined, as it had previously, that Blixseth’s appeal was not equitably moot. Because the court had the capacity to fashion a remedy that would resolve Blixseth’s appeal, at least in part, the appeal was not moot. Furthermore, because the Ninth Circuit had already ruled on the issue, its prior decision was binding as law of the case.

Nonetheless, since Blixseth’s appeal involved only questions of law regarding the validity of the exculpation, the Ninth Circuit proceeded to the merits of Blixseth’s appeal: whether the bankruptcy court could release Credit Suisse, as a creditor, from liability for certain potential claims against it by approving the exculpation provision. The basis for Blixseth’s argument was that the exculpation amounted to a discharge of the debt of a non-debtor under section 524(e). Considering the history and purpose of section 524(e), the court concluded that section 524(e) was intended to prevent non-debtors from discharging debts on which they were co-liable with the debtors, and for which the debtors had received a discharge. Because the claims released in the exculpation provision were unrelated to the Yellowstone Entities’ discharged debts, the limitation in section 524(e) did not apply to bar the exculpation provision at issue.

§ 1.1.11 Tenth Circuit

Drivetrain, LLC v. Kozel (In re Abengoa Bioenergy Biomass of Kansas, LLC), No. 18-3120 (10th Cir. May 5, 2020). The Tenth Circuit Court of Appeals extended the applicability of its equitable mootness doctrine to Chapter 11 plans of liquidation, rather than limiting the doctrine solely to plans of reorganization.

Debtor Abengoa Bioenergy Biomass of Kansas (“ABBK”), which constructed and operated an ethanol conversion facility in Kansas with the financial support of its four subsidiaries, converted a Chapter 7 proceeding into a voluntary petition for reorganization pursuant to Chapter 11. The bankruptcy plan was confirmed, over Drivetrain’s objection, and substantially consummated when ABBK auctioned the Kansas facility and distributed most of the estate’s other assets to creditors, subordinating all inter-company claims.

Drivetrain sought to stay the plan’s enforcement and implementation, which the bankruptcy court denied on the ground that Drivetrain had failed to demonstrate a likelihood of success in overturning the plan. Drivetrain appealed the stay denial, while the ABBK trustee moved before the district court to dismiss Drivetrain’s appeal of the plan confirmation as equitably moot, given that the plan had been substantially consummated. After the district court granted that motion, on the basis that a successful appeal of the plan confirmation could harm innocent third-party creditors, the Tenth Circuit consolidated both matters on appeal.

Drivetrain argued that the equitable mootness doctrine only applies to conventional reorganizations—not cash-only liquidations under Chapter 11. However, the Tenth Circuit held that the flexible, multi-factor test guiding equitable mootness in the context of substantially completed plans—factors which include, among other things, the effect of the relief requested on the plan and the harm to third parties who have justifiably relied on the plan’s confirmation—does apply to Chapter 11 liquidation plans. Abengoa Bioenergy Biomass of Kansas, LLC, 958 F.3d 949, 956 (10th Cir. 2020) (citing Search Market Direct, Inc. v. Paige (In re Paige), 584 F.3d 1327, 1335 (10th Cir. 2009)). The court noted that other circuits (including the Tenth Circuit) have affirmed equitable mootness rulings within the context of Chapter 11, and refused to “erect a categorical bar to equitable mootness in the context of a Chapter 11 liquidation.” Id. at 957. The court found that the factors in the Paige test—in particular, the impact on reorganization, the costs created by ongoing litigation, and the benefits provided by a successful reorganization—enable courts to evaluate the propriety of equitable mootness within the context of a cash-only liquidation. Id. at 954 n.3, 956.

The court then applied the six-factor Paige inquiry and found that, among other things, the substantial consummation of the plan, the negative effects of reversing the plan on innocent third parties’ rights, and the need for creditors to be able to rely upon decisions of the bankruptcy court, weighed in favor of equitable mootness. Accordingly, the Tenth Circuit held that the district court did not abuse its discretion in dismissing Drivetrain’s appeal of the confirmed plan of liquidation as equitably moot.

In re Rumsey Land Co., LLC, 944 F.3d 1259, 1265 (10th Cir. 2019). Debtor Rumsey Land Company, LLC (“Rumsey”) commenced the adversary proceeding that spawned this appeal against Pueblo Bank & Trust Company, LLC (“PBT”) and Resource Land Holdings (“RLH”) in 2015, asserting, among other things, claims for fraudulent concealment and violations of section 363(n)’s prohibition on collusive bidding. The bankruptcy sale in question took place in 2011. The Tenth Circuit affirmed the decision of the district court dismissing the claims on various grounds, although the court emphasized that the alternative forms of relief demanded in connection with the section 363(n) claim needed to be addressed separately.

Rumsey filed for bankruptcy in January 2010. Soon thereafter, in March 2010, Rumsey sought to sell certain real property, encumbered by a first deed of trust held by PBT, to RLH for approximately $7.5 million. However, multiple creditors objected to the transaction and the bankruptcy court ordered that Rumsey market the property more broadly.

In December 2010, having failed to purchase the property directly from Rumsey in the bankruptcy sale, RLH signed a loan purchase agreement with PBT to purchase Rumsey’s debt. However, on February 1, 2011, PBT refused to close on the loan purchase agreement. Thereafter, RLH sued PBT to enforce the loan purchase agreement. Rumsey did not know about the loan purchase agreement or the lawsuit at the time.

Meanwhile, in March 2011, Rumsey obtained bankruptcy court approval of its sale and notice procedures. RLH submitted a $4 million stalking horse bid in cash. PBT submitted a competing $5 million credit bid as the stalking horse bid. Rumsey chose to proceed using PBT’s $5 million credit bid as stalking horse. Although a third party was selected as the winning bid in May 2011, when the successful bidder was not able to close in August 2011, Rumsey accepted PBT’s bid as the backup.

In September 2011, RLH and PBT settled their lawsuit. As part of the settlement, PBT and RLH agreed that RLH would buy the Rumsey property from PBT for $4.75 million after the bankruptcy sale. After the bankruptcy sale to PBT closed on October 6, 2011, PBT then transferred the property to RLH on October 13. Rumsey did not learn of this transaction until 2015, at which point Rumsey initiated the adversary proceeding against PBT and RLH, alleging six causes of action on the premise that they entered into a secret, collusive agreement that undermined the auction. After RLH filed a motion to withdraw the reference, the proceedings were transferred to the district court where summary judgment was granted on the merits on all six claims.

Only Rumsey’s fraudulent concealment claim and collusive bidding claim under section 363(n) were challenged on appeal. With regards to fraudulent concealment, as to RLH, the circuit court ruled that RLH was not a party to a business transaction with Rumsey and had no duty to disclose any information to Rumsey. As to PBT, the court ruled that Rumsey had waived its claim for fraudulent concealment against PBT because Rumsey failed to advance any specific arguments regarding PBT’s duty to disclose. With regard to the collusive bidding claim under section 363(n), the circuit court found that the district court had erred by considering both Rumsey’s claim for damages and avoidance of the bankruptcy sale barred by Federal Rule of Civil Procedure 60(c)(1). Instead, the court determined that the Rule 60(c)(1) limitation applied only to Rumsey’s claim to avoid the sale; the claim for damages was not barred by Rule 60(c)(1). Nonetheless, the district court did not err in its ruling because, as the circuit ruled, Rumsey had failed to prove that the purpose of PBT and RLH’s agreement was to control the price of Rumsey’s original section 363 sale.

§ 1.1.12 Eleventh Circuit

In re Bay Circle Properties LLC, 955 F.3d 874 (2020). The Eleventh Circuit Court of Appeals added further clarity to the parameters for standing to bring an appeal of a bankruptcy court order when it held that an individual who is not himself the owner of a parcel of real property on which a creditor foreclosed, but only asserts some undefined “beneficial” interest therein and claims to be the guarantor of underlying debt, lacked standing not only because he had suffered no injury but also because he was not a “person aggrieved” by an order of the bankruptcy court.

This case featured co-plaintiffs Chittranjan Thakkar (“Thakkar”) and DCT Systems Group, LLC (“DCT”), with which Thakkar claim to “affiliated.” Both Thakkar and DCT had separate loans issued by Wells Fargo. When DCT declared bankruptcy, both parties entered into a settlement agreement with the bank, offering two properties DCT owned and to which Thakkar asserted a “beneficial interest” as collateral for the loans. The settlement agreement included a deeds-in-lieu-of-foreclosure remedy, which allowed Wells Fargo to recover the encumbered property without necessity of a foreclosure judgment. At some point thereafter, Wells Fargo sold its interest in the settlement to Bay Point Capital Partners (“Bay Point”). DCT subsequently defaulted on the loans and Bay Point chose to record the properties deeds and pursue foreclosure on both properties. Two days before the foreclosure sale, DCT purported to offer $2.8 million in payment of the remaining debt to Bay Point, but Bay Point did not respond to the offer. Bay Point then sold the properties through the foreclosure sale for $2.85 million.

Thakkar and DCT sued Bay Point in state court, alleging that Bay Point’s foreclosure of the two properties caused Thakkar to lose the collateral’s value exceeding the debt balance and to suffer mental anguish. Bay Point removed the case to the U.S. Bankruptcy Court for the Northern District of Georgia and moved for judgment on the pleadings, which the bankruptcy court granted. The District Court for the Northern District of Georgia affirmed the bankruptcy court’s ruling in all respects. Originally, both Thakkar and DCT appealed to the circuit court, but DCT eventually settled with Bay Point, agreeing to relinquish all claims regarding the two properties. As a result, Thakkar became the sole appellant, challenging both Bay Point’s decision to record both properties deeds, as opposed to one, and Bay Point’s failure to accept the purportedly proper “tender.”

The Eleventh Circuit analyzed the three elements for Article III standing to determine that Thakkar alone did not have standing to bring the case because he had not suffered an injury personal to him. The court noted that DCT undoubtedly had standing, but since it had relinquished all claims, Thakkar could “no longer piggyback” on its standing. Since Thakkar pled that it was DCT that owned the two properties and failed to elaborate on his “beneficial interest” in DCT, the court could not find that Thakkar personally suffered an actual injury.

The court also found that Thakkar did not have standing under the “person aggrieved doctrine,” which limits the right to appeal a bankruptcy court order to those parties having a direct and substantial interest in the question being appealed. The standard imposes an additional limitation on constitutional standing, over and above Article III’s requirements. The court found that Thakkar’s inability to articulate his financial interest in DCT’s properties meant that he was not directly harmed by the bankruptcy court’s order. In addition, the Court dismissed Thakkar’s argument that the lack of “inherent fairness of the bankruptcy proceeding” was sufficient to meet the “person aggrieved” standard because his interest in the DCT properties did not fall within the scope of the Bankruptcy Code.

By: Business and Corporate Litigation Committee, Business Law Section, American Bar Association May 14, 2021

§ 1.1 Recent Bankruptcy Litigation Decisions

§ 1.1.1 United States Supreme Court

§ 1.1.2 First Circuit

§ 1.1.3 Second Circuit

§ 1.1.4 Third Circuit

§ 1.1.5 Fourth Circuit

§ 1.1.6 Fifth Circuit

§ 1.1.7 Sixth Circuit

§ 1.1.8 Seventh Circuit

§ 1.1.9 Eighth Circuit

§ 1.1.10 Ninth Circuit

§ 1.1.11 Tenth Circuit

§ 1.1.12 Eleventh Circuit

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