On April 21, 2023, the English High Court handed down its written reasons for sanctioning the Adler Group restructuring plan proposed under the new Part 26A regime of the UK’s Companies Act 2006, which raises questions regarding the jurisdiction of the court, cross-class cramdowns, pari passu issues, and competing valuations.
Following the introduction of a new restructuring regime in the Cayman Islands, we delve into the ramifications of the recent Adler Group decision and its potential impact on further revisions to the Cayman Islands Companies Act.
Background
The Adler Group, a prominent German property group owning a rental property portfolio valued at approximately €8 billion, faced a myriad of liquidity challenges following the impact of ratings downgrades, regulatory/bondholder scrutiny, and short-selling pressure. The Adler Group had six series of unsecured notes maturing in 2024, 2025, 2026, 2027, 2028, and 2029 (“Notes”). One of the Adler Group’s subsidiaries had Notes with a maturity date of April 27, 2023, which it was not going to be able to meet and was likely to trigger default of the Notes under their various covenants.
Following an unsuccessful attempt to implement a restructure contractually with the noteholders, the Adler Group incorporated a new company under English law and substituted that new company as the issuer of the Notes in order to launch a restructuring plan under Part 26A of the Companies Act 2006. The restructuring plan, among other things, proposed to do the following (together, the “Plan”):
introduce €937 million of new senior secured debt to repay the Notes maturing on April 27, 2023, and the 2024 Notes, in exchange for a super-senior first-ranking lien and a 22.5 percent equity interest post-restructure;
extend the maturity date of the 2024 Notes until July 31, 2025, in exchange for priority over other noteholders in terms of repayment (maturity of all other Notes to remain the same); and
amend the remaining Notes to allow refinancing and receive payment-in-kind (“PIK”) interest and a subordinated security interest.
The Plan was not aimed at continuing the Adler Group as a going concern but was designed to keep the Adler Group solvent for a sufficient period of time to allow for a solvent winding-down and sale of its real estate assets by the end of 2026, as opposed to a compulsory liquidation (which was agreed by the parties to be the relevant alternative to the Plan).
An ad hoc group of 2029 noteholders (“AHG”) opposed the Plan and emphatically challenged the Plan in the English High Court at both the convening hearing and the sanction hearing, which involved conflicting expert valuation evidence and cross-examination.
The AHG’s Opposition to the Plan
The AHG argued that there was no nexus to the UK for the court to have jurisdiction to sanction the Plan other than the recently established subsidiary that was substituted as the issuer of the Notes. Furthermore, the AHG argued that the Plan was in direct conflict with the pari passu principle as the Plan, if sanctioned, would create differential treatment between noteholders and was unfairly prejudicial to 2029 noteholders in particular as the holders of the Notes with the latest maturity date, ranking last in repayment due to subordination.
The AHG argued that the position of 2029 noteholders was further unfairly impacted by the fact that now €937 million of new debt would need to be repaid before any money would be distributed to noteholders, as opposed to a liquidation (without the Plan) where all Notes would rank pari passu in repayment.
The English Court’s Decision
The court ultimately rejected the AHG’s objections and sanctioned the Plan, acknowledging the complexion of the evidence submitted by each party and the time sensitivity of the restructure due to the April 27, 2023, maturity of some of the Notes.
In reaching its decision, the court made a number of findings (some of which were the first of its kind for a Part 26A proceeding).
It had jurisdiction to sanction the Plan. Notwithstanding the lack of nexus to English law, the court found that the substitution of the newly incorporated English company as the issuer of the Notes was sufficient for the court to consider the sanction of the Plan under Part 26A of the Companies Act 2006. The AHG has brought a claim in a German court to challenge the validity of this point.
The valuation evidence provided by the Adler Group regarding the sale value of the Adler Group was more persuasive than the evidence provided by the AHG. This was the first time that a dissenting party to a Part 26A proceeding actually submitted competing evidence with regard to the valuation of the relevant company in the event of liquidation (including likely discounts). The court acknowledged the uncertainty of the valuations provided by both parties, but ultimately preferred the Adler Group’s valuation and noted that upon implementation of the Plan, the most likely outcome (but not necessarily the definite outcome) would be that noteholders are paid in full.
The Plan was not a departure from the pari passu principle. The court noted that even if the Plan failed and the Notes had to be accelerated, the noteholders would then be paid in accordance with the pari passu principle. It also noted that if the Plan succeeded, then all noteholders would most likely be paid in full, as opposed to the alternative (liquidation), where noteholders would receive a fraction of their debt.
The 2029 noteholders assumed the risks involved with Notes maturing in 2029, which was a commercial decision. It was noted that the terms of the 2029 Notes reflect the commercial risks that the AHG (along with the other 2029 noteholders, the majority of which supported the Plan) assumed and that, therefore, it could not argue that the maturity date of the 2029 Notes should be amended.
The court had discretion to enforce a cross-class cramdown notwithstanding that both conditions weren’t met. The court noted that each class of noteholder approved the Plan with the requisite majority (75 percent), except for the 2029 noteholders (62 percent). However, it took into account the fact that the majority of 2029 noteholders did approve of the Plan and that the noteholders would not be any worse off by the Plan, as the most likely scenario was that they would be paid in full.
Cross-Class Cramdowns and Dissenting Rights: Balancing Stakeholder Interests
Within the restructuring arena, the concept of cross-class cramdowns (common in US Chapter 11 proceedings and now part of the UK restructuring regime) emerges as a crucial tool for striking a balance between conflicting stakeholder interests. Cross-class cramdowns empower courts to approve a restructuring plan, even in the face of objections from dissenting creditors. In the Adler Group case, the court leveraged this mechanism to sanction the Plan notwithstanding the AHG’s dissent, the AHG’s conflicting valuation expert evidence, and the fact that both conditions under section 901G of the Companies Act 2006 were not strictly satisfied.
In order to sanction the Plan while there were dissenting creditors, the court had to consider whether the following conditions were met:
The dissenting class (the AHG) would not be any worse off than they would be in a liquidation (as the accepted “relevant alternative” by all parties if the Plan wasn’t sanctioned)—that is, the No Worse Off Test.
At least 75 percent (in value) of each class of creditors agreed to the Plan—that is, the Genuine Economic Interest Test.
Despite falling short of the 75 percent approval requirement under section 901G of the Companies Act 2006 with regard to the 2029 noteholders, the court exercised its discretion by taking into account that the No Worse Off Test was satisfied and that 62 percent of 2029 noteholders did approve the Plan.
Relevance to the Cayman Islands’ Restructuring and Insolvency Landscape
Against the backdrop of recent developments and revisions to the Cayman Islands Companies Act to introduce the “Restructuring Officer” regime, the Adler Group decision is important and may provide hints of what is likely to be the next area for revision. Under the Cayman Islands Companies Act, there are no prescribed dissenting or appraisal rights in this context. While the legislature and/or courts are unlikely to be persuaded to introduce a new dissenting rights regime similar to that of the US, the flexibility of the Part 26A tool, as showcased in the Adler Group decision, may be the pragmatic middle ground.
Richard “Dick” Duesenberg, former chair of the ABA Business Law Section in 1987–1988, passed away in August 2023. During his tenure as chair, the Section changed its name from the Corporation, Banking, and Business Law Section to the more simple: Business Law Section.
“Dick was the general counsel of Monsanto Corporation, where he assembled what was considered then to be one of the best in-house legal departments in the country,” said Maury B. Poscover, former chair of the ABA Business Law Section, 1997–98. “He was dedicated to his alma mater, Valparaiso University. Both Dick and his twin brother, Bob, were significant financial supporters to Valparaiso.”
Mr. Duesenberg earned his undergraduate and law degrees from Valparaiso University and a Master of Laws degree from Yale Law School.
Mr. Duesenberg joined the law department of the Monsanto Company in 1962 and, from 1977 to 1995, served as Senior Vice President, General Counsel & Secretary of Monsanto.
Besides his active involvement in and proud affiliation with the ABA’s Business Law Section, Mr. Duesenberg served as chairman of the American Society of Corporate Secretaries and vice president of the Association of General Counsels, and he was on the boards of directors of the National Judicial College and the American Arbitration Association. He was a Life Member of the American Law Institute and a Fellow of the American Bar Foundation.
As author of many legal articles, treatises, book chapters, and editorials, Mr. Duesenberg leaves behind impressive writing contributions on many substantive business law topics.
In 2022, I moved from the Kent County business court to the Michigan Court of Appeals, where I now serve as one of twenty-five judges on our state’s intermediate appellate court. Since I made that move, many friends have asked me how the change has gone. I tell them that I used to have real power because I could issue an opinion or order any time I wanted and it could say anything I liked, but now I can’t do anything without getting someone to agree with me.
That lighthearted description of my new role downplays the profound impact that my responsibility these days in writing precedential opinions has had on my concern about the rule of law. The job of serving on an appellate court is dramatically different from serving as a trial-court judge. I no longer exist in a vacuum. Now, everything must be done by consensus, and the goal is getting to an agreement that expeditiously moves appeals through the system. And it’s all about counting votes.
Justice William Brennan once remarked of the U.S. Supreme Court that “five votes can do anything around here.” Sadly, history has proven that aphorism to be true. In the early days of the Supreme Court, Chief Justice John Marshall somehow convinced all of his colleagues that it was inadvisable to dissent. What resulted was a steady flow of unanimous decisions largely written by Chief Justice Marshall that created the appearance of consistent consensus. To be sure, the legal world was largely deprived of the genius of Justice Joseph Story because of that arrangement that too often kept him out of the writing business of the Supreme Court, but there was real value in unanimity in the major cases of the era.
Comparing that type of unanimity in major cases with the muddled mess in narrowly divided decisions reveals why the Supreme Court works most effectively when it speaks with one voice. In Brown v. Board of Education, Chief Justice Earl Warren patiently and diligently worked to produce a unanimous opinion that would leave no doubt that the Supreme Court was committed to desegregation as a matter of constitutional imperative. Compare that to one of the most poorly conceived opinions in Supreme Court history, Lochner v. New York, where a closely divided Supreme Court relied upon substantive due process to enshrine the economic right to freedom from workplace regulations as an ineluctable constitutional mandate. Justice Oliver Wendell Holmes wrote a blistering dissent warning the majority of the error of its ways, and you know you’re probably on the wrong side of the constitution if Justice Holmes vigorously opposes what you’re doing. Indeed, it took thirty-two years and a full-blown constitutional court-packing crisis to clean up the mess that Lochner made.
Which brings me back to my humble role on the Michigan Court of Appeals. There’s a school of thought that an effective appellate judge is someone who waits for the right panel configuration to write the judge’s preferences into law, knowing that a second vote for any outcome is readily available. That’s not me. Some ideological judges may regard their work on the bench as painting on a blank canvas. I see myself as a technician, working to reach the correct result in every single case by faithfully applying precedent and neutral principles, no matter what my personal preferences may be. Some might characterize that approach as relegating me to the status of a pedestrian purveyor of judicial authority—neither a visionary nor a groundbreaker. But that view served me well as a business-court judge, and I’m now perfectly comfortable in that role on the Michigan Court of Appeals because I’m such a devout believer in judicial modesty.
The power of judicial review is a dangerous concept in the wrong hands. It can insulate policy preferences from the salutary process of debate, deliberation, and collective decision-making in our constitutional republic. Judicial activism through the extravagant use of the power of judicial review cuts off that entire process.
That’s why my commitment to judicial modesty discourages me from thinking about counting to two when I write an opinion for our court. Instead, I always do my best to count to three. When I am sitting with two colleagues who rarely agree on much of anything, I could easily write an opinion based on my personal preference, knowing that I’ll have a second vote no matter how I analyze the case. But I much prefer to write opinions that can garner the support of both of my colleagues, comfortable in the understanding that a consensus among those of us with divergent judicial philosophies almost certainly will be the correct answer to the issue presented on appeal.
In my first year on the Michigan Court of Appeals, I wrote only one separate opinion. It was a dissent in a case that was assigned to me in the first instance as the lead writer. When my colleagues and I discussed the case in our post-argument conference, I realized that my view was the minority approach. That left the three of us in the awkward position of deciding who would write the majority opinion. To my colleagues’ bemusement, I volunteered to write the majority opinion as well as my own dissent. I’m pleased to report that the majority opinion I drafted not only won the approval of both of my colleagues but also nearly convinced me to change my own vote. And that, in my view, is how an appellate court protects and preserves the rule of law.
So, when I am next up for election, if the voters are looking for a culture warrior who is ready to storm the battlements in developing precedent, I’m not their judge. But if the voting public wants somebody who will work tirelessly for consensus even when it is hard to find, I’m probably their cup of tea, even though I’ll never be part of a judicial Boston Tea Party. That, in my view, is what best sustains and fortifies the rule of law that we all rightfully cherish.
The cannabis industry, just like any other industry, requires insurance coverage. Insurance is often required for plant-touching businesses such as growers, processors, and dispensaries and is well-advised for ancillary cannabis businesses, such as real estate brokerages, transportation companies, and payment processors. While the cannabis industry is rapidly making its mark on the U.S. economy as more states pass laws to legalize its use (both medicinally and recreationally), the cannabis insurance industry, by comparison, has been slow to adapt to the expanding need for cannabis insurance. As a result, cannabis businesses are oftentimes left with spotty coverage, high premiums, and more questions than answers.
InsuranceBasics
Insurance products are generally offered in two markets: the admitted market and the surplus lines market.
Insurance products offered in the admitted market are typical, also known as “off the shelf” products, e.g., insurance for personal use vehicles, residential housing, life and health, travel, and more. These products are easily accessible, and most national insurance companies sell these products to the general public with ease of marketing.
The surplus insurance market, in contrast, is meant to fill the gaps for insurance products and offerings that are not readily available in the admitted market. Products in the surplus lines market can cover unique items of value or certain risks that require individualized underwriting to determine the value. Tom Brady’s arm during the many seasons in which he played and Beyoncé’s voice are examples of unique “risks” covered by a specialized insurance product not offered in the general marketplace.
In order for an insurance product to be considered in the surplus lines market, most states will require that at least three insurance companies turn down writing this type of coverage in the general admitted market.
Finding Cannabis Insurance
With the emergence of businesses newly operating in the small-to-medium markets of the cannabis industry, so too has emerged the need for insurance coverage. In fact, many states’ regulatory schemes require insurance policies meeting specific coverage guidelines in order to obtain the requisite licensing for storefronts, cannabis-related services, transportation, etc.
Unfortunately, in most jurisdictions, insurance (especially competitively priced insurance) is difficult to find. Brokers who sell insurance are less likely, depending on the state, to advertise they can offer insurance for cannabis-related businesses.
However, some states—such as California, which has a more mature cannabis market—publish a list of brokers and insurance companies that offer insurance products for cannabis-related industries so they may be more readily accessible to cannabis licensees and ancillary businesses. Ultimately, if coverage can be located, it will most likely be surplus lines coverage.
A Look Forward
The insurance industry has an express interest in covering these higher risks and business-related activities, but due to factors such as the potential higher premium-to-loss ratios, insurance companies often find themselves unsure of what insurance products to offer and how to offer cannabis insurance products in the admitted market.
How products for the cannabis industry will be underwritten and how premiums are determined in most cases is a black box of strategy. Due to the nascent nature of the legal cannabis industry, there are relatively few historical metrics on which to rely for creating such pricing compared to other high-risk industries. This is yet another reason insurance products for the cannabis industry are most commonly offered in the surplus lines market: because the cannabis industry rates are not yet regulated by states, there is typically little to no state guidance on how to set relevant rates or underwrite these specific kinds of risks.
While how to offer insurance-related products to marijuana and marijuana-related businesses is on the minds of regulators throughout the United States, regulators are unsure of how to propose such regulations in light of these challenges and when the industry is still illegal under federal law.
Alabama Takes Action
As explained above, cannabis insurance—to the extent it is offered—is typically packaged as a surplus line, and states have been slow to roll out relevant guidance. However, changes are on the horizon.
Recently, the Alabama Department of Insurance (DOI) issued Bulletin No. 2023-03 titled “Creation of a Medical Cannabis Insurance Market in Alabama.” The Bulletin is a future directive that all “commercial property and casualty medical cannabis-related rate, rule, or combination filings” be filed with the Alabama DOI. The Bulletin’s future directives are procedural in nature: “encourag[ing]” insurers to “submit rates and forms” for use with marijuana licensees. The relevant submissions “will” (future tense) be made under Ala. Admin. Code r. 481-1-123-.03 (File and Use System).
There was no date of implementation, or deadline for compliance, provided in the Bulletin. Once implemented, however, the Bulletin states File and Use Rates will continue for three years or until the DOI can properly forecast rates based on statewide experience.
Alabama legalized the medicinal use of marijuana in 2021. The Alabama DOI likely took this step to issue the Bulletin in May 2023 because the state closed its cannabis license application window at the end of 2022, and the Alabama Medical Cannabis Commission awarded medical cannabis business licenses in June 2023 and August 2023. The state required applicants to submit, as part of their Applicant’s Verified Business Plan, “[a]n insurance plan, including declarations pages and letters of intent, if any, from an A-rated insurer as to, at a minimum, casualty, workers’ compensation, liability, and (as applicable) auto or fleet policy.” Ala. Admin. Code r. 538-x-3-.05(3)(m)(15)(k), Contents of Application. Alabama’s regulations also deem applicants ineligible to receive a license if “[t]he Applicant fails to demonstrate the ability to maintain adequate minimum levels of liability and casualty insurance or other financial guarantees for its proposed facility.” Ala. Admin. Code r. 538-x-3-.14, Ineligibility for License. Thus, the need for cannabis-related insurance in Alabama is surging.
The DOI’s likely intent in implementing this procedure through the issuance of the Bulletin is to allow the DOI to gather facts at present and, later, administer and enact laws and regulations regarding marijuana-related insurance products and coverage, rates, and more.
Next Steps
Changes to the cannabis insurance landscape, such as the emergence of admitted market lines, are on the horizon and will likely be implemented in the future. As more states pass laws to legalize the use of marijuana, it is expected that the transition from surplus lines to the admitted market will accelerate. Businesses involved in the cannabis industry—including direct, plant-touching companies as well as ancillary product or service providers—must be mindful of their insurance obligations in each jurisdiction in which they operate and should keep their fingers on the pulse of these issues as the cannabis market continues to expand and mature.
Committee on Foreign Investment in the United States (“CFIUS”) regulations have increasingly been in the news. There is good reason—CFIUS regulations have become more robust to address U.S. national security concerns. Given this, business lawyers should consider CFIUS implications when advising on any transactions or investments, to include real estate transactions, involving foreign persons.[1] Below is a brief summary of ten things a business lawyer should know when working on transactions involving foreign entities or persons.
What Is CFIUS? CFIUS is an interagency committee, chaired by the Secretary of the Treasury, charged with the duty to review certain foreign investment in the United States to assess whether the transaction may impact U.S. national security.[2] Since Treasury chairs the committee, Treasury maintains a website with useful information on CFIUS and manages the CFIUS Case Management System used for CFIUS filings.[3]
Other CFIUS members include the Departments of Justice, Commerce, Defense, State, and Energy as well as the Office of the U.S. Trade Representative and the Office of Science & Technology Policy.[4] White House offices, such as the National Security Council and the Council for Economic Advisors, as well as the Director of National Intelligence and the Department of Labor, may also provide input during the review process.[5]
What Is the Purpose of CFIUS? Although CFIUS reviews foreign investment in the U.S., CFIUS is not designed to limit or impede foreign investment in the U.S. Its mission is to protect U.S. national security.[6] Through the years, the U.S. government has made this clear by explaining that foreign investment is welcomed, and, given the strength of the U.S. economy; U.S. policies encouraging economic growth; the U.S. spirit of innovation; and the sophistication of U.S. financial markets, it is the best place in the world to invest.[7]
What Is the Legal Construct for CFIUS? Through executive orders, laws, and regulations dating back to 1975, the president is given authority to suspend or prohibit foreign investment that may impact U.S. national security.[8] CFIUS regulations implement these requirements.[9] The Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”) updated CFIUS regulations to address U.S. national security risks as a result of the changing geopolitical landscape to include, among other things, expanding the types of transactions that must be disclosed to CFIUS.[10]
What Types of Real Estate Transactions Must CFIUS Review? CFIUS reviews “covered real estate transactions” as that term and related terms are defined in CFIUS regulations.[11] Generally, these regulations require CFIUS review of real estate transactions involving foreign persons related to real estate in and around certain airports, ports, and military bases that are either listed by name in the regulations or published by the Department of Transportation.[12]
What Types of Transactions and Investments Are Subject to CFIUS Jurisdiction? CFIUS has jurisdiction over “covered control transactions” and “covered investments,” which are transactions and investments that could result in a foreign person controlling a U.S. business.[13] CFIUS regulations broadly define “control” and may even include minority investment in some situations.[14] CFIUS also has jurisdiction over direct or indirect investment by a foreign person in a U.S. Technology, Infrastructure, Data (“TID”) U.S. business, even if non-controlling, if a foreign person will have access to material non-public technical information in the possession of the TID U.S. business; board membership; observer rights; rights to nominate individuals to the governing body of the TID U.S. business; or involvement in substantive decision-making of the TID U.S. business regarding sensitive personal data of U.S. citizens maintained or collected by the TID U.S. business, or critical technologies, or covered investment in critical infrastructure.[15]
For purposes of CFIUS, critical technology includes producing, designing, testing, manufacturing, fabricating, or developing technology or critical components that are essential to U.S. national security.[16] Covered infrastructure transactions include foreign investment in systems or assets, whether physical or virtual, so vital to the U.S. that their incapacity or destruction would be debilitating, like energy infrastructure or major telecommunications infrastructure.[17] Data is sensitive personal data on U.S. persons that the business maintains or collects directly or indirectly.[18]
Only certain transactions mandate disclosure to CFIUS. A disclosure to CFIUS is mandatory if the transaction involves a foreign person and TID U.S. business that produces, designs, tests, manufactures, fabricates, or develops “critical technologies” that are controlled by U.S. export regulations.[19] CFIUS disclosure is also mandatory if a foreign government, even if indirectly, will obtain “substantial interest,” as that term is defined in CFIUS regulations, in a TID U.S. business.[20]
Other than these situations, disclosing to CFIUS is voluntary. Since CFIUS may unwind a transaction, even after closing, if the transaction impacts national security, parties should assess whether filing a voluntary notice with CFIUS would be prudent. Voluntary notices allow for the possibility of CFIUS clearing the transaction, thus for the most part mitigating the risk that CFIUS will review, and possibly unwind, the transaction at a later date in the interest of national security.
CFIUS regulations include some exemptions for certain passive investment and for transactions involving close U.S. allies.
What Is the Process for CFIUS Review? Filings are submitted to the Treasury through its online system. Generally, the parties work together to file with CFIUS. Parties may choose to file a declaration, which is an abbreviated disclosure form.[21] CFIUS has thirty days to act on declarations by clearing the transaction; requiring the parties to file a notice, which requires more information than a declaration and extends the review period; or ending review without a formal clearance.[22] If parties do not receive formal clearance or direction to file the longer notice, it conveys that CFIUS did not have concerns with the transaction, but it is not as definitive as if CFIUS had cleared the transaction. For mandatory declarations, the parties must file their declaration with CFIUS at least thirty days before the transaction’s expected completion date.[23]
Parties to a transaction may elect to file a voluntary notice.[24] Generally, notices require far more information than does a declaration, and notices have a longer review process. Once CFIUS has what it considers a complete filing, it has forty-five days to assess the filed notice.[25] If CFIUS cannot make its assessment on a notice within the forty-five-day review period, CFIUS will initiate an investigation, which it has forty-five days to complete. If needed, after an investigation, CFIUS has fifteen days to obtain presidential review of the transaction.
The CFIUS review takes longer than regulations suggest. For purposes of starting the CFIUS review clock, Day 1 is not the day a CFIUS notice is filed. Instead, the clock starts on the day Treasury accepts a notice. which is the day after Treasury has determined that the notice complies with filing requirements; confirmed that the filing fee has either been paid or was waived; and all CFIUS members have received the notice. The time it takes to get to Day 1 depends on a number of factors, including whether the notice included all required information and whether CFIUS decides to ask for additional information.
Are There Other Legal Considerations When a Transaction Involves Foreign Investment? CFIUS regulations may not be the only disclosures a U.S. business must file when it is involved in transactions with foreign persons. For example, export regulations International Traffic in Arms Regulations (ITAR) and Export Administration Regulations (EAR),[26] and the National Industrial Security Program Operating Manual (NISPOM),[27] which regulates U.S. government contractors with classified contracts, also require notice to designated government agencies for review and approval of transactions involving foreign entities. Notifying CFIUS of a transaction does not fulfill these legal obligations. Finally, review by the agencies that manage export regulations and the NISPOM may actually take longer than the CFIUS review.
Does CFIUS Accept Risk Mitigation Strategies to Blunt National Security Risks in a Transaction? CFIUS may approve a transaction but require the parties to implement mitigation strategies that may limit foreign control or limit or prohibit access to a business’s critical technology in the interest of national security. [28] Treasury’s Office of CFIUS Monitoring and Enforcement has the authority to monitor mitigation plans. Further, other agencies charged with protecting national security through export regulations or through the NISPOM may independently require that a business obtain export licenses or implement other controls pursuant to export and NISPOM regulations.
Are CFIUS Filings Confidential? Information provided to CFIUS must be maintained in confidence.[29] CFIUS may not disclose whether a transaction has been submitted for review. Given the nature of CFIUS filings, the information filed is exempt from public disclosure under the Freedom of Information Act. If parties to a transaction reveal they have submitted a transaction to CFIUS for review, CFIUS may then comment publicly.
What Are CFIUS Penalties? CFIUS requirements give the president authority to prohibit certain foreign investment in the United States, to include the authority to suspend or unwind a transaction that implicates national security. There are also financial penalties up to $250,000 per violation for intentionally or negligently submitting a material misstatement or omitting material information in a CFIUS filing. If CFIUS orders an entity to implement a mitigation plan and the entity either intentionally or negligently violates the plan, the entity may incur a civil penalty up to $ 250,000 per violation or for the value of the transaction, whichever is greater. Since mitigation agreements may include liquidated or actual damages for breaches, offending entities may be liable for damages in addition to the civil penalties.[30]
Foreign person is a defined term in CFIUS regulations. 31 CFR 800.224, Foreign person. ↑
U.S. Department of Treasury, CFIUS Overview (last visited Sept. 20, 2023). ↑
See, e.g., Executive Order 11858 (May 1975) as amended by Executive Order 13456 (Jan. 2008); Executive Order 14083 (Sept. 15, 2022); § 721 of the Defense Production Act of 1950, as amended; 31 CFR Part 800. ↑
Make-whole provisions in most debt instruments traditionally are structured either as a make-whole based on simple interest or a straight percentage premium that ratchets down over time. In the current market, in which many private equity sponsors and other investors are leveraging debt as a means of avoiding repricing their investments, we are noticing a convergence of the characteristics of debt and equity return hurdles: debt financing parties are now more likely than ever to dip into the private equity toolkit by utilizing equity-like economic sweeteners for lenders. These provisions can appeal to both borrowers and lenders because they enable borrowers to conserve near-term cash and incentivize debt investments while hardwiring lenders’ returns on their debt investments in anticipation of a near-term exit or other realization event. While equity-like sweeteners can be useful tools under the right circumstances, they may pose heightened risks for lenders in a downside scenario. These risks, as well as the tax implications of such equity-like sweeteners, should be taken into account when negotiating debt financing transactions.
This article will examine some of these equity-like sweeteners, why they have become popular, and the risks and structuring considerations for investors considering including such provisions in their financing terms.
What Are the Most Common Equity-Like Sweeteners?
Multiple on invested capital (“MOIC”) and internal rate of return (“IRR”) are two of the most common metrics used to calculate return on investment in private equity, and they are also two of the most common equity-like sweeteners gaining popularity among lenders. An investor modeling for a near-term exit event will likely prefer to employ a MOIC, whereas an investor anticipating a longer exit timeline might prefer to include an IRR make-whole because it takes into account the time value of money invested.
Why Have Equity-Like Sweeteners Become Popular?
Equity-like sweeteners are a natural development in the evolution of the private equity and venture capital worlds’ business model of highly leveraged investing. Debt secured by future cash flows is now common. The idea is to use leverage to invest in a company’s balance sheet and infrastructure at a fixed coupon until the investment reaches a threshold value—and at that point, use funds received in a realization event (e.g., an exit) rather than from operations to refinance or repay the debt.
While these financings may be more expensive than traditional cash pay investments, they are often cheaper than another round of equity raising and, as a result, have become popular tools to allow companies to harness growth, avoid down rounds, and improve the returns for their management team and equity investors. An equity-like kicker allows the business to use tomorrow’s upside to finance current growth and pay a present-day cash coupon that it can support based on current revenue. While lenders may not receive regular cash flow income at a high interest rate during the life of the investment, locking in a fixed return is an attractive outcome, particularly for debt investors such as insurance companies and private credit funds, and allows the sourcing parties to be compensated for work, time, and cost involved with sourcing the investment.
Downside Case Considerations
It is presently unclear how equity-like sweeteners will fare in a downside case (which may be precipitated or exacerbated by the stress of the current market conditions, in which timelines for exits are being extended, real costs and cash burn are increasing, and valuation multiples are being compressed). Equity-like sweeteners have yet to be fully tested in bankruptcy. They share certain attributes with traditional make-wholes, and there is consequently a real concern that in light of the recent decisions on make-wholes in the Ultra Petroleum Corp. v. Ad Hoc Committee of OpCo Unsecured Creditors[1] and Wells Fargo Bank, N.A. v. Hertz Corp.[2] bankruptcy cases, they may be vulnerable to disallowance in a downside case, including based on treatment as “unmatured interest” under section 502(b)(2) of the Bankruptcy Code.
Section 502(b)(2) of the Bankruptcy Code generally disallows claims for “unmatured interest.” While this term is not formally defined in the Bankruptcy Code, it has been construed by courts to mean interest that is not yet earned or due and payable as of the date of a bankruptcy filing. Historically, a majority of courts allowed make-whole premiums to the extent validly triggered under the applicable debt documents (which issue was frequently subject to dispute), finding that such premiums constituted reasonable liquidated damages designed to compensate lenders for the cost of reinvesting in a less favorable market, rather than unmatured interest.
However, in Ultra and Hertz, the courts rejected the distinction between liquidated damages and unmatured interest and adopted an expansive view under section 502(b)(2) of the Bankruptcy Code. In Ultra, the U.S. Court of Appeals for the Fifth Circuit found that the make-whole at issue was the “economic equivalent” of unmatured interest. In Hertz, the U.S. Bankruptcy Court for the District of Delaware reached the same conclusion after examining the “economic substance” of the applicable make-whole. Both courts acknowledged that make-wholes may be allowable in some instances but found that the premiums at issue, which were calculated using interest-based formulas, represented claims for unmatured interest rather than noninterest damages such as reinvestment costs. While the full impact of the Ultra and Hertz decisions—the latter of which is subject to ongoing appeal—remains to be determined, the decisions increase the risk that a debt investor who agreed to price a deal up front based on a fixed-return hurdle may now find its borrowers considering bankruptcy as a way to avoid paying a significant piece of the investor’s expected compensation for its debt investment. Investors may become more circumspect about the likelihood of achieving that return in a downside case as a result.
Given the expansive view of unmatured interest taken by the Ultra and Hertz courts, it is possible that if the same courts were presented with an equity-like sweetener, claims for amounts owed under such provisions (or for other amounts not expressly calculated by reference to future interest, such as exit fees and other fixed fees) may also be viewed as the economic equivalent of unmatured interest.[3] Alternatively, a court might distinguish such equity-like sweeteners as less directly tethered to future unearned interest than the make-wholes in Ultra and Hertz, but investors should be mindful that the existing case law leaves room for debate.
In addition, equity-like sweeteners may be challenged as unenforceable penalties/unreasonable fees even where they do not constitute unmatured interest, especially if the borrower is under financial distress or facing imminent financial distress when such consideration is negotiated.[4] Debtors and/or creditors’ committees often challenge make-wholes as unenforceable penalties subject to disallowance. Equity-like sweeteners that are perceived as overly aggressive may risk disallowance under section 502(b)(1) of the Bankruptcy Code[5] (and/or, if the claim for the premium is fully secured such that section 506(b) of the Bankruptcy Code applies, as an unreasonable fee[6]).
Tax Efficiency Considerations
Equity-like sweeteners based on a MOIC or IRR hurdle may result in “phantom income” for an investor because debt instruments with these terms provide for a payment at an unknown future date for an unknown amount. As a result, such debt instruments may be treated as “contingent payment debt instruments” (“CPDIs”) under the Internal Revenue Code unless an exception applies. Additionally, any gain resulting from the MOIC or IRR hurdle is generally taxed as ordinary income instead of capital gains.
A debt instrument is treated as a CPDI if it provides for one or more payments that are not fixed as to time or amount and that are not “remote” or “incidental.”[7] A contingency is treated as “remote” if the likelihood that it will occur (or not occur) is remote.[8] A contingency is treated as “incidental” if the amount of the contingent payment under all reasonably expected market conditions is insignificant relative to the total expected payments on the debt instrument.[9]
To avoid having a debt instrument with a MOIC or IRR or similar equity-like sweetener treated as a CPDI, the borrower would need to be able to represent to the satisfaction of the investor and its tax return preparers that the likelihood of a triggering event is remote and that the CPDI rules should not apply. Context matters, and debt instruments containing equity-like sweeteners ideally should be structured in a way that utilizes one of the exceptions. For example, in the circumstance where a borrower is an investment grade company, a default that triggers traditional make-whole, MOIC, or IRR payments will likely be treated as a remote contingency that will not cause a debt instrument to be treated as a CPDI at the time of issuance.
However, if no exception applies, a borrower would construct a hypothetical payment schedule for the CPDI based on a “comparable yield,” which generally is the rate at which the applicable issuer could issue a fixed-rate debt instrument with terms and conditions similar to the applicable debt. The investor holding such debt instrument would agree upon such schedule with the borrower and accrue interest income from the initial issuance date based on the projected payment schedule, with adjustments if the actual contingent payments differ from the projected payments.[10]
While such phantom income is not unusual in a CPDI, in light of the Ultra and Hertz decisions, investors should be aware that if the equity-like sweetener contained in their debt instrument is disallowed in bankruptcy, the investor not only would be exposed to the lost investment upside but also would possibly have current tax liabilities to pay (and may have potentially passed such tax liabilities on to its own investors) without ever realizing any cash return on the investment. Additionally, income would be taxed at ordinary income rates, while any losses realized on the debt instrument would be capital losses.
Balancing Downside Case and Tax Considerations in Protecting Investor Economics
Even if an equity-like sweetener is potentially unenforceable in bankruptcy, it may still serve as a valuable means of preserving upside for lenders not only in out-of-court exit scenarios such as a sale, refinancing, or prepayment but also by giving companies runway to grow. To avoid the outcome described immediately above, debt investors need to balance the desire to preserve upside recoveries against the desire to manage tax liabilities and maximize the chances of the equity-like sweetener being enforceable in a downside scenario.
Investors should carefully consider the default and acceleration provisions in proposed debt documents to ensure that any equity-like sweetener will be validly triggered if the debt is accelerated before the anticipated exit event—but should also bear in mind that the ability to accelerate an equity-like sweetener will not necessarily ensure its collectibility in bankruptcy. Bankruptcy-triggered acceleration is generally disregarded for purposes of determining whether a claim for interest has matured under section 502(b)(2) of the Bankruptcy Code,[11] and courts have reached differing conclusions as to whether prepetition acceleration suffices to protect against disallowance under section 502(b)(2) where the claim is for the economic equivalent of unmatured postpetition interest.[12]
Having the equity-like sweetener earned up front and paid later rather than earned at the time of a realization event may help to mitigate the risk of disallowance under section 502(b)(2) of the Bankruptcy Code. However, the efficacy of this largely untested tactic is uncertain given that (1) a court may not accept the contractual characterization of the equity-like sweetener as “earned” to the extent the court finds that such amount is intended to compensate for future interest; and (2) even if fully earned, the equity-like sweetener may still be deemed “unmatured” to the extent that it is not due and payable as of the bankruptcy filing. In addition, there is a cost to this approach: upon recognition of this revenue (at the time so earned), the investor (and its own investors) would need to treat the whole amount as fee income for tax purposes without having commensurate cash flows to offset the liability, and the investor (and its own investors) would carry the risk that the amount is never actually paid.
Another potential way to reduce challenge risk in bankruptcy is to include language in the debt documents clarifying the intent of the parties and the specific rationale for the equity-like sweetener—i.e., that the equity-like sweetener is designed to compensate for damages other than future interest streams and is reasonable under the circumstances. While there is no guarantee that such language will be persuasive to a court (both the Ultra and Hertz courts emphasized that the economic reality rather than the labels given by the parties in their agreement dictated whether a given claim was for unmatured interest), it may at least create additional room for argument by providing evidence of the parties’ understanding at the time of the transaction. The persuasive force of such argument may depend, in part, on the ability to credibly articulate the specific noninterest damages for which the equity-like sweetener is designed to compensate the investor (as well as on the underlying economic terms and financial condition of the borrower at the time such financing is entered into). It remains to be seen whether equity-like sweeteners will face other bankruptcy risks (e.g., recharacterization) in addition to implicating the risks faced by traditional make-whole claims.
In addition to addressing bankruptcy challenge risk in the up-front structuring for equity-like sweeteners, lenders may also mitigate such risk at the time of the bankruptcy filing by negotiating debtor-in-possession financing that refinances the equity-like sweetener at the outset of the bankruptcy case and/or by making favorable treatment of the equity-like sweetener part of a comprehensive restructuring support agreement—assuming the debtor is willing to agree to such terms. These later-stage mitigation strategies can be subject to challenge by creditors’ committees and other interested parties but may enhance lenders’ chances of recovering potentially controversial claims.
What Should I Do If I Have an Equity-Like Sweetener in My Debt Documents?
General Considerations for All Debt Financing Parties
Lender-Specific Considerations
For existing deals, engage counsel to (1) review the debt documents and consider whether an amendment to clarify the nature of your premiums is advisable and (2) assess your strategic options if a bankruptcy filing by the borrower appears imminent.
For new deals:
Consult with counsel to ensure that the debt documents contain the latest market language for addressing premiums as well as the latest bankruptcy and tax technology (tailored to the interests of the relevant debt financing party).
Establish ample documentation of the parties’ understanding regarding the basis for any equity-like sweeteners.
Engage in discussion with tax advisers early on.
In general, consider notice and reporting obligations and best practices for investors regarding changes in the nature of the obligations and changes in risk profile. (If nothing else, equity-like sweeteners implicate potential underwriting and disclosure risks given the lack of precedent regarding their treatment in bankruptcy.) Also, set alerts for updates on the appeal in Hertz, and keep abreast of new cases involving make-wholes and their close cousins, equity-like sweeteners.
For existing deals, if a bankruptcy filing by the borrower appears imminent, consult with counsel to determine whether any risk-mitigation options may be available in connection with such bankruptcy filing (e.g., in connection with the negotiation of any debtor-in-possession financing and/or restructuring support agreement).
For new deals:
Ensure that deal documentation reflects the noninterest basis for, and reasonableness of, any equity-like sweeteners.
Consider requiring the authorization of such items to be provided via board meeting and involve—appropriately documented in the meeting minutes—a detailed and separate discussion of the premium and, if applicable, any CPDI schedule (potentially including written materials prepared by and discussed with advisers), with an opportunity to ask questions.
Consider requiring MOIC/IRR cash payments in connection with a realization or mandatory prepayment event to de-risk a potential bankruptcy situation (tax advisers may be able to assist with durational structuring of MOIC/IRR kickers to minimize tax liability while accounting for deal downside risk).
Ultra Petroleum Corp. v. Ad Hoc Comm. of OpCo Unsecured Creditors (In re Ultra Petroleum Corp.), 51 F.4th 138 (5th Cir. 2022), cert. denied, No. 22-772, 2023 WL 3571513 (May 22, 2023). ↑
See Wells Fargo Bank, N.A. v. Hertz Corp. (In re Hertz Corp.), Adv. No. 21-50995 (MFW), at 6–12 (Bankr. D. Del. Nov. 21, 2022), ECF No. 71; see also Wells Fargo Bank, N.A. v. Hertz Corp. (In re Hertz Corp.), 637 B.R. 781, 785 (Bankr. D. Del. 2021). ↑
A similar argument was raised by the creditors’ committee in In re Talen Energy Supply, LLC, another recent bankruptcy case, prior to the Ultra and Hertz decisions. See Objection of the Official Committee of Unsecured Creditors to Proof of Claim by Alter Domus (US) LLC, as Administrative Agent, In re Talen Energy Supply, LLC, No. 22-90054 (MI), ¶¶ 61–64 (Bankr. S.D. Tex. Aug. 22, 2022), ECF No. 1088 (arguing that MOIC premium should be disallowed under section 502(b)(2) to the extent it incorporated a make-whole that was allegedly subject to disallowance as unmatured interest). ↑
In both Talen and another recent case involving a contractual premium negotiated shortly before the borrowers’ bankruptcy filing, the creditors’ committee argued that the premium at issue was an unenforceable penalty and/or unreasonable because the bankruptcy filing was foreseeable when the debtors committed to pay the premium. Therefore, the creditors’ committee asserted, the lenders had no real expectation of the future interest stream that the premium was ostensibly intended to protect and were instead seeking to improperly inflate their recoveries in the borrowers’ bankruptcy cases. See id. ¶¶ 38, 44–51; Notice of Filing Proposed Redacted Version of the Official Committee of Unsecured Creditors of TPC Group et al., for Entry of an Order Granting (I) Leave, Standing, and Authority to Commence and Prosecute Certain Claims on Behalf of the Debtors’ Estates and (II) Exclusive Settlement Authority in Respect of Such Claims, In re TPC Group Inc., No. 22-10493 (CTG), ¶¶ 99–104 (Bankr. D. Del. Sept. 6, 2022), ECF No. 725. In both cases, the disputes were settled prior to adjudication. ↑
Section 502(b)(1) generally disallows claims to the extent unenforceable under the applicable agreement or nonbankruptcy law. ↑
Section 506(b) permits fully secured creditors to recover “reasonable fees, costs, or charges” provided for under the applicable agreement or state law under which the claim arose. ↑
If the actual amount of the equity-like kicker payment equals the projected payment amount, then there are no additional taxes paid at the time of receipt. If the actual amount of the payment differs, the difference, if positive, will be treated as additional interest income; and if negative, it will reduce interest income in the year of payment, and the excess will be treated as ordinary loss to the extent of prior interest inclusions. Thus, in certain circumstances, amounts that are not actually interest can be treated as taxable interest income in earlier years, with corresponding losses in later years. Depending on the structure of the lender, losses may be subject to limitations. ↑
Some debtors and creditors’ committees have further argued that enforcement of bankruptcy-based acceleration triggers for make-wholes is prohibited under sections 365(e)(1), 541(c)(1)(B), and 363(l) of the Bankruptcy Code (which restrict enforcement of ipso facto clauses, i.e., contractual rights conditioned on the debtor’s bankruptcy, insolvency, or financial condition). There is limited case law on this issue, which remains subject to debate. ↑
Compare, e.g., In re Harris, No. 18-16598, 2022 WL 198852, at *7 (Bankr. N.D. Ohio Jan. 21, 2022) (finding that prepayment premium triggered prepetition was “fully matured” and thus not “unmatured interest” under section 502(b)(2), and collecting supporting cases), aff’d sub nom. Harris v. Synovus Bank, No. 1:22-cv-00247, 2022 WL 17750281 (N.D. Ohio Dec. 19, 2022), with, e.g., Ultra Petroleum Corp. v. Ad Hoc Comm. of OpCo Unsecured Creditors (In re Ultra Petroleum Corp.), 51 F.4th 138, 147 (5th Cir. 2022) (stating that even if creditors could establish that make-whole premium was not technically “unmatured” and/or not technically “interest,” make-whole premium claim may nevertheless be subject to disallowance as economic equivalent of unmatured interest under section 502(b)(2)). ↑
The Eastern District of Pennsylvania Bankruptcy Conference (EDPABC) is a nonprofit organization that was formed in 1988 to promote the education and interests of its members and the citizens of the Commonwealth of Pennsylvania residing in the ten counties within the United States District Court for the Eastern District of Pennsylvania. Members include lawyers, other professionals, and paraprofessionals who specialize in the practice of Bankruptcy and Creditors’ Rights law in the Eastern District of Pennsylvania. Please visit EDPABC’s website, www.pabankruptcy.org, for more information or to join the organization.
Materials Preview
Each year, the EDPABC’s Education Committee formulates challenging hypotheticals based on recent case law. At the EDPABC’s Annual Forum, typically held in late-March/early-April each year, professors from local law schools facilitate lively discussions among EDPABC members about the hypotheticals in small-group breakout sessions. The hypotheticals are always engaging—and sometimes deliberately ambiguous—to mirror the complexity of everyday practice and foster debate among even the most seasoned bankruptcy professionals.
The hypotheticals are accompanied by summaries of the underlying case law and other relevant authorities inspiring the fact patterns. The summaries are intended to give readers insights into how similar issues have been argued before and decided by the courts and to inform their answers to the questions presented in the hypotheticals.
This hypothetical from a previous Forum, titled “Succession Planning in Legacy Media Conglomerates,” describes the fictional bankruptcy of a media conglomerate “Waystar/Royco” caused by massive tort liability resulting from a lack of confidence in news reporting due to officer and director meddling in the news stories the company published, as well as a Department of Labor investigation into its employment practices. The hypothetical raises questions around bankruptcy court jurisdiction over enjoining third-party litigation, assumption of executory contracts, violations of the automatic stay, and other issues.
Succession Planning in Legacy Media Conglomerates: Case Problem
Waystar/Royco (Waystar) is a multinational corporation headquartered in Philadelphia with multiple business lines, including cable news, theme parks, and cruise ship lines. Waystar was a public company, but the majority of its shares were owned through a holding company controlled by various trusts established by Waystar founder and CEO Logan Roy and his family.
In early 2021, Waystar’s flagship company, Waystar News (News), ran several stories about Cyberdyne Systems Inc., a prominent defense contractor. News’s two most prominent program hosts, Tom Tucker and Diane Simmons, each produced and ran multiple segments on their respective shows making incredible allegations that Cyberdyne was developing an artificial intelligence program that would control all nuclear weapons in the United States. Whether the allegations were true was widely disputed, but Congress banned the reported program under the TERMINATOR Act of 1985, and Cyberdyne’s share price plummeted.
Cyberdyne filed a defamation action against Tucker, Simmons, and News alleging $1 billion in damages. News immediately began paying all legal fees and expenses that Tucker and Simmons incurred in the defamation action, even though they did not have formal indemnification agreements with News. Instead, subject to exceptions for gross negligence or willful misconduct, News historically indemnified its employees in all defamation actions filed or threatened against them, including for their attorneys’ fees and costs, judgments, and settlements, as set forth in its employee policy manual and handbook.
Initial discovery in the defamation action revealed that Logan Roy had longstanding personal issues with certain members of Cyberdyne’s board of directors and had been influential in pushing News to run stories for several years attacking Cyberdyne and its board members. Emails showed that Tucker and Simmons initially had serious problems with the accuracy of their reporting on Cyberdyne, but that Roy ultimately persuaded them to follow through with their segments.
Cyberdyne’s action triggered the filing of a tidal wave of defamation actions against Tucker, Simmons, and News by various individuals and businesses who were aggrieved by News’s questionable coverage over the years. Overwhelmed by this litigation and because of the lagging performance of its other business lines, Waystar caused itself and each of its subsidiaries to file jointly administered chapter 11 cases in the Eastern District of Pennsylvania on December 1, 2021 (the Petition Date).
Question 1
Due to the volume of litigation and the resulting expense, News stops indemnifying Tucker and Simmons in all defamation actions, except Cyberdyne’s. However, News promptly files an adversary proceeding in its bankruptcy case seeking a preliminary and permanent injunction extending the automatic stay to protect non-debtors Tucker and Simmons from Cyberdyne’s defamation action, as well as from the other defamation actions.
An ad hoc committee of plaintiffs (the Ad Hoc Committee) objects to News’s request for a preliminary injunction. The Ad Hoc Committee asserts that the Court lacks subject-matter jurisdiction over the adversary proceedings necessary to enter the injunction. News argues that the Court has related-to jurisdiction under the “conceivable effects” test applied in Purdue Pharmaceuticals based on its indemnification obligations to Tucker and Simmons. The Ad Hoc Committee disputes that the indemnification obligations are sufficient to establish jurisdiction based on the elevated standard for related-to jurisdiction in the Third Circuit.
A: What arguments can News and the Ad Hoc Committee make to establish their respective positions? What arguments can News make to distinguish the Third Circuit’s standard, or persuade the Court to apply a lesser standard, and how should the Ad Hoc Committee respond? How should the Court decide these issues?
After hearing the parties’ arguments, the Court declines to apply the lesser standard from Purdue Pharmaceuticals and holds that News’s indemnification obligations do not establish related-to jurisdiction. However, it requests briefing from the parties on whether it has jurisdiction on any other grounds, including based on the risk that News will be bound by the factual and legal determinations decided in the actions against Tucker and Simmons (if they are not stayed) pursuant to collateral estoppel. The Court states that it will issue an oral ruling at a subsequent hearing on whether it will issue a preliminary injunction.
B: What arguments can the Ad Hoc Committee make against jurisdiction based on collateral estoppel? Does News have any alternative grounds to argue for related-to jurisdiction over the defamation actions?
After receiving the parties’ briefing, the Court schedules a hearing to announce its decision. It agrees with News that the Court has related-to jurisdiction. Further, the Court finds that grounds exist to extend the automatic stay to Tucker and Simmons, thus it reaches the question of whether News has satisfied the test for issuance of a preliminary injunction.
C. What factors should the Court consider in its ruling on whether failure to stay the defamation actions will cause irreparable harm to News? Is there a public interest in allowing the defamation actions to continue? What should the Court’s ruling be?
The purpose of this question is to elicit discussion of the issues raised in Union Trust Phila., LLC v. Singer Equip. Co (In re Union Trust Phila., LLC), 460 B.R. 644 (E.D. Pa. 2011); Int’l Union of Painters & Allied Trades Dist. Council No. 21 Health & Welfare Fund v. Ser. Painting, Inc.,2019 WL 2143370 (E.D. Pa. May 16, 2019); In re Fed.-Mogul Glob., Inc., 300 F.3d 368 (3d Cir. 2002); and Dunaway v. Purdue Pharms. L.P. (In re Purdue Pharms. L.P.), 619 B.R. 38 (S.D.N.Y. 2020).
Question 2
In the year before filing for bankruptcy, Waystar’s theme parks division, Waystar Parks (Parks), had commissioned a documentary about the origins of its amusement parks and how it had constructed its highlight attraction, “Way to the Stars,” an indoor rollercoaster that led its riders on a simulated voyage through space narrated by Tucker and Simmons. Naturally, Tucker and Simmons had also narrated the documentary, for which services they were entitled to 10 percent of the documentary’s profits for the first two years after its debut, as set forth in their “Documentary Narration Contracts.” Notably, the contracts included an additional covenant obligating Tucker and Simmons to appear at monthly events during that two-year period to promote the documentary in various markets around the United States. A separate provision of the contracts made it a condition precedent to all profit payments that Tucker and Simmons not be in breach of their obligations relating to the promotional events. However, the events could be cancelled by News at its sole discretion upon notice to Tucker and Simmons.
Against all odds and despite being critically panned, the documentary was a hit among the general public, generating incredible streaming revenue and giving rise to substantially greater profit obligations to Tucker and Simmons than expected. While it was preparing to file its bankruptcy case, News decided to withhold the profit payments it owed to Tucker and Simmons to generate additional case liquidity.
Shortly after the Petition Date, Tucker and Simmons file a motion to compel News to assume or reject the narration contracts, arguing that the contracts are executory and that if News desires to assume the contracts and continue streaming the documentary, the required cure costs include all outstanding profit payments.
News opposes the motion, arguing that Tucker’s and Simmons’s promotional event obligations are not material unperformed obligations rendering the contracts executory. Tucker and Simmons respond that the terms of the contracts express the parties’ agreement that their promotional event obligations are material to News’s profit payment obligations, which they argue should control the question of materiality. What facts support and detract from their arguments? How should the Court rule? How could the contracts have xbeen drafted differently to potentially reach a different result?
Would it comport with the policies underlying the assumption and rejection provisions of the Bankruptcy Code if the Court were to hold that the contracts were not executory? Would such a holding be fair to Tucker and Simmons?
Assume that the promotional event obligations were material, but that the day before the Petition Date, News gave Tucker and Simmons notice that it was cancelling all remaining promotional events. Would the contracts still be executory? What arguments could Tucker and Simmons make?
The purpose of this question is to elicit discussion of the issues raised in Spyglass Media Grp., LLC v. Bruce Cohen Prods. (In re Weinstein Co. Holdings, LLC), 997 F.3d 497 (3d Cir. 2021); Gen. DataComm Indus., Inc. v. Arcara (In re Gen. DataComm Indus., Inc.), 407 F.3d 616 (3d Cir. 2005); and In re Sea Oaks Country Club, LLC, 2020 WL 6588412 (Bankr. D.N.J. 2020).
Question 3
Parks had always generated substantial revenue, but operated at a very low margin. Thus, over a period of several years before filing chapter 11, Parks began implementing extreme cost-cutting measures. As a result, Parks’ internal recordkeeping system degraded and its managers began pressuring employees to clock out, but continue working after their shifts ended, to avoid paying overtime. However, nine months prior to filing, Parks’ management endeavored to correct these issues, fixing its internal systems, and beginning to provide back pay to the hourly employees entitled to it, albeit in phases over twenty-four months to minimize the impact on its cash flows.
Parks was aware that it was under investigation by the Department of Labor and informed the Department of its efforts. However, the Department took two positions. First, it asserted that the phased back pay was unacceptable, and that Parks must make all back payments immediately. Second, the Department requested all relevant books and records from Parks to verify that every employee was receiving what they were entitled to.
Around the same time that Cyberdyne filed its defamation action against News, the Department filed an action against Parks in the United States District Court for the Western District of Pennsylvania, alleging that Parks violated the Fair Labor Standards Act by failing to pay adequate overtime wages and by failing to maintain proper records. The Department sought two injunctions, one requiring immediate payment in full of the back pay and another requiring Parks to turn over its books and records.
However, on the Petition Date, Parks files a suggestion of bankruptcy with the District Court. In response, the Department files a motion seeking a determination that its suit is not enjoined by the automatic stay, asserting that it falls within the police powers exception under section 362(b)(4).
The Department argues that it is engaging in litigation to promote the government’s public policy interest in the general welfare of employees. Parks argues that the Department is using its police power to enforce the private rights of individual employees. Which argument is more compelling? Considering the District Court’s decision in Stewart v. Holland Acquisitions, Inc., should the automatic stay apply to the Department’s suit?
Assuming Parks did cure the back pay fully, but still would not voluntarily turn over its books and records, is the injunctive relief sought by the Department proper?
The purpose of this question is to elicit a discussion of the issues raised in Stewart v. Holland Acquisitions, Inc., 2021 WL 1037617 (W.D. Pa. Mar. 18, 2021); and Chao v. Hosp. Staffing Servs., Inc., 270 F.3d 374 (6th Cir. 2001).
Question 4
Waystar also sells certain tech hardware, namely, set-top boxes for its proprietary streaming services. These boxes are manufactured by ABC Manufacturing pursuant to a Manufacturing and Shipping Agreement (the MSA), under which ABC will also receive boxes returned by Waystar for upgrades or repairs. Waystar’s payment terms under the MSA are 30 days from the invoice date. ABC used a third-party vendor, XYZ Logistics, to store and ship Waystar’s boxes, pursuant to a Warehousing and Shipping Agreement (the WSA).
Several months before the Petition Date, Waystar began missing payments, which constituted defaults under the MSA. Around the same time, Waystar also returned approximately 15,000 boxes, worth a total of $1.5 million, to ABC for upgrades as part of a new design intended to help Waystar compete with Amazon’s Firestick. Based on Waystar’s defaults, ABC exercised its remedies under the MSA to require that Waystar pay for the upgrades and shipping on cash-in-advance terms. Waystar complied. However, by the time the upgrades to the boxes were completed and the boxes were transported to XYZ’s warehouse, but before the Petition Date, Waystar had accrued a substantial unpaid arrearage on orders it had placed for new boxes. Accordingly, ABC directed XYZ not to ship the upgraded boxes to Waystar, as permitted under the MSA and WSA.
After the Petition Date, Waystar sends a letter to ABC demanding that it release the hold it placed on the upgraded boxes and have them shipped to Waystar. Because Waystar still owes a substantial pre-petition arrearage on its orders for new boxes, ABC sends a response opposing Waystar’s request to release the hold and stating that it will not have the boxes shipped to Waystar. Both Waystar and ABC copy XYZ on their correspondence.
Waystar files a motion requesting damages for a willful violation of the automatic stay against ABC, arguing that its refusal to release the hold and have the upgraded boxes shipped to Waystar constitutes an act to collect a debt in violation of section 362(a)(6). What arguments should the parties make as to the alleged stay violation? How should the Court rule?
Assume that the Court holds that ABC’s refusal to release the hold and ship the upgraded boxes to Waystar violated the automatic stay. ABC argues that in light of the Supreme Court’s decision in City of Chicago v. Fulton, it had acted in good faith in its belief that it was not violating the automatic stay. Is ABC correct in its position that even if it violated the automatic stay, it did not commit a willful stay violation?
The purpose of this question is to elicit discussion of the issues raised in Cal. Coast Univ. v. Aleckna (In re Aleckna), 13 F.4th 337 (3d Cir. 2021); City of Chicago v. Fulton 141 S. Ct. 585 (2021); Margavitch v. Southlake Holdings, LLC (In re Margavitch), 2021 WL 4597760 (M.D. Pa. Oct. 6, 2021); and Cordova v. City of Chicago (In re Cordova), 2021 WL 5774400 (Bankr. N.D. Ill. Dec. 6, 2021).
Authority Summaries for Question 1
Union Trust Phila., LLC v. Singer Equip. Co (In re Union Trust Phila., LLC), 460 B.R. 644 (E.D. Pa. 2011)
Background
In April 2009, Singer Equipment Company, Inc. sued Chestnut Restaurant Ventures, LLC (CRV), along with Joseph Grasso and Garrett Miller as members of CRV, in the Court of Common Pleas of Philadelphia for amounts allegedly owed for purchases of restaurant equipment. In August 2010, CRV transferred all of its assets, including the equipment interests, to another entity owned by Grasso and Miller, Union Trust Philadelphia, LLC.
In March 2011, Union Trust filed for bankruptcy under chapter 11 in the Eastern District of Pennsylvania. Shortly thereafter, the Court of Common Pleas entered a judgment enforcing a settlement agreement among the parties to the state court proceeding, from which judgment Grasso and Miller appealed. Union Trust then commenced an adversary proceeding against Singer, seeking an injunction under section 105(a) of the Bankruptcy Code to enjoin the state court proceeding and extend the automatic stay under section 362(a) to Grasso and Miller. The Bankruptcy Court granted a preliminary injunction that would expire at the end of August 2011 to provide Union Trust with sufficient time to prepare and submit a plan of reorganization. Singer appealed to the District Court.
Analysis
The District Court followed the three-step analysis from In rePhiladelphia Newspapers, LLC, 407 B.R. 606 (E.D. Pa. 2009), to determine if the preliminary injunction was properly issued by the Bankruptcy Court. Under the three-part analysis, the District Court must determine whether the Bankruptcy Court (1) “had jurisdiction to issue the injunction,” (2) “properly extended the § 362(a) stay” to the non-debtor parties, and (3) “properly exercised its discretion in issuing the injunction pursuant to section 105(a).” The District Court emphasized that, “[u]nless all three steps of the analysis are satisfied, an injunction should not issue.”[1]
Jurisdiction
First, the District Court discussed whether the Bankruptcy Court had jurisdiction to issue the injunction. A bankruptcy court has jurisdiction to enjoin proceedings between third parties only if those proceedings arise in, arise under, or are related to the underlying bankruptcy. Related-to jurisdiction exists where “the outcome of that proceeding could conceivably have any effect on the estate being administered in bankruptcy.” Pacor v. Higgins, 743 F.2d 984, 994 (3d Cir. 1984).
“[T]he parties principally dispute[d] whether the Bankruptcy Court had ‘related to’ jurisdiction over the state court proceedings.” Union Trust argued that the Bankruptcy Court had related-to jurisdiction because the state court proceeding triggered a contractual provision requiring indemnification of Grasso and Miller. Union Trust also argued that the Bankruptcy Court had related-to jurisdiction because the state court proceeding would impact its reorganization efforts and the value of its assets. In response, Singer argued that the Bankruptcy Court lacked related-to jurisdiction because, “contrary to Union Trust’s contention,” Union Trust was not obligated to indemnify Grasso and Miller. Further, even if it were so obligated, Union Trust’s indemnification obligations would not “sufficiently affect the administration of the bankruptcy estate.”
The District Court found that while Union Trust might have owed indemnification obligations, that was insufficient on its own to establish related-to jurisdiction. “A bankruptcy court lacks ‘related to’ jurisdiction over a third-party action ‘if the only way in which that third-party action could have an impact on the debtor’s estate is through the intervention of yet another lawsuit.’” Thus, common law indemnity obligations would not establish related-to jurisdiction. Further, “while a contractual right to indemnity may present ‘a more direct threat’ to reorganization,” even contractual indemnification obligations do not “in all cases” establish jurisdiction. Whether they do depends on “a fact-specific, case-by-case basis.”
Union Trust’s purported indemnification obligations were set forth in its Operating Agreement. Singer argued that the relevant provision only entitled Grasso and Miller to indemnification for costs incurred because of actions taken in connection with the performance of their duties to Union Trust. Despite their testimony on the issue, and the fact that Union Trust had already been paying Grasso’s and Miller’s legal fees for the state court proceeding pre-petition, the District Court concluded that the “limited record” concerning the indemnity did not allow it to determine whether state court proceeding was within the scope of the indemnification provision in Union Trust’s Operating Agreement. Therefore, the Bankruptcy Court did not have related-to jurisdiction based on Union Trust’s indemnification obligations.
However, the District Court still found that the state court proceeding would have an impact on Union Trust’s reorganization efforts sufficient to establish related-to jurisdiction.
First, the District Court agreed with Union Trust’s argument that Grasso and Miller were crucial to the reorganization efforts and that continuation of the state court proceeding would therefore adversely impact the reorganization by consuming their time and resources. For example, both were actively involved in obtaining financing for the reorganization, guaranteed a loan commitment to help fund the reorganization, and made “substantial” payments on behalf of Union Trust since the bankruptcy filing. Further, Grasso and Miller extensively participated in Union Trust’s operations and daily business decisions.
Second, the District Court credited Union Trust’s argument that, “if the state proceedings are allowed to continue, it could be barred from relitigating issues decided in those proceedings by operation of collateral estoppel.” Indeed, because of their “prior legal or representative relationship,” the District Court found privity between Union Trust, Grasso, and Miller sufficient to preclude Union Trust from relitigating the state court’s factual and legal determinations even though it was not a party to that proceeding.[2]
Accordingly, the District Court held that “Union Trust’s potential indemnification obligations and the impact on Union Trust’s reorganization efforts, taken together, provide an adequate basis for the court to find that the state court proceedings are sufficiently ‘related to’ the underlying bankruptcy.” The Bankruptcy Court therefore had jurisdiction to issue the injunction.
Extension of Stay
Next, the District Court discussed whether the Bankruptcy Court properly extended the automatic stay to Grasso and Miller. The automatic stay under section 362(a) only stays actions against a debtor, but can be extended to non-debtor third parties if “unusual circumstances” exist. Unusual circumstances exist where either (1) “there is such identity between the debtor and the third-party defendant that the debtor may be said to be the real party defendant and that a judgment against the third-party defendant will in effect be a judgment or finding against the debtor” or (2) “stay protection is essential to the debtor’s efforts of reorganization.”
The District Court found the second situation to be present due to the involvement by Grasso and Miller in the restructuring efforts. Similar to its finding that the Bankruptcy Court had related-to jurisdiction, the District Court relied on the active involvement of both Grasso and Miller in the case and financial support and assurances of Union Trust to be essential to restructuring efforts and without such, Union Trust’s ability to reorganize would diminish. However, the District Court also found that “the record supports the existence of an identity of interests among Union Trust, Grasso, and Miller,” because Union Trust was “potentially obligated to indemnify them in connection with [the state court] proceedings.” Thus, the Bankruptcy Court properly extended the automatic stay to Grasso and Miller.
Injunction Pursuant to Section 105(a)
Finally, the District Court discussed whether the Bankruptcy Court properly exercised its discretion to issue the injunction under section 105(a). The District Court recited a four-factor test for issuance of a preliminary injunction: “(1) whether the movant has shown a reasonable probability of success on the merits; (2) whether the movant will be irreparably injured by denial of the relief; (3) whether granting preliminary relief will result in even greater harm to the nonmoving party; and (4) whether granting the preliminary relief will be in the public interest.”
The District Court held that the Bankruptcy Court did not abuse its discretion to issue a preliminary injunction under these factors. First, Union Trust showed that a successful reorganization was viable because it had negotiated cash collateral agreements, was making adequate protection payments, and continued to operate its restaurant. Second, Union Trust showed that there would be irreparable harm in the absence of an injunction because it would diminish Grasso’s and Miller’s ability to assist in reorganization. Third, the District Court found that the injunction would not cause greater harm to Singer, as the injunction was of limited duration and the Bankruptcy Court would revisit the continuation of the injunction if necessary. Further, Singer failed to identify any harm that would be caused by the injunction. Finally, the District Court found that the preliminary injunction was in the public interest because it protected the reorganization and claims resolution process, and the success of reorganization would be hindered without staying the state court proceeding.
Conclusion
The District Court held that the Bankruptcy Court had jurisdiction to issue the preliminary injunction, the Bankruptcy Court’s finding of unusual circumstances to extend the stay was not clearly erroneous, and the Bankruptcy Court did not abuse its discretion in issuing the injunction.
Int’l Union of Painters & Allied Trades Dist. Council No. 21 Health & Welfare Fund v. Ser. Painting, Inc., Civ. No. 18-3480, 2019 WL 2143370 (E.D. Pa. May 16, 2019)
Background
The international Union of Painters and Allied Trades District Council 21’s Employee Fund (the Funds) sued Service Painting, Inc., as well as its president and main shareholder, Nick Garavelas, under the Employee Retirement Income Security Act (ERISA). Service Painting and Garavelas failed to respond to the complaint and, when the Funds moved for default judgment, Service Painting filed for chapter 11 relief. As a result, the court placed the case in suspense.
The Funds thereafter moved to re-open the ERISA case against Garavelas only, as he was a non-debtor and therefore not subject to the automatic stay. Garavelas failed to respond to the motion and the court set a damages hearing. After Garavelas’s counsel entered an appearance and a negotiation took place, the Funds withdrew their default motion, expedited discovery took place, and the damages hearing was reset. After the hearing, the court ordered the Funds to show cause why the court could proceed against Garavelas individually.
Analysis
Garavelas argued that the automatic stay should apply to him as a non-debtor for two reasons. First, “a finding in [the ERISA] case could affect Service Painting’s bankruptcy proceedings.” Second, a ruling in the ERISA case “could preclude the bankruptcy estate from challenging [those] findings.”
The court, relying on Forcine Concrete & Constr. Co. v. Manning Equip. Sales & Serv., 426 B.R. 520 (E.D. Pa. 2010), described two situations in which courts will extend the automatic stay to non-debtors: (1) where extension of the stay would be “essential” to a debtor’s reorganization efforts; and (2) where there is “such identity between the debtor and the third-party” that a judgment against the non-debtor would be a judgment against the debtor. The second situation arises when a debtor would be forced to indemnify the co-defendants if there was an adverse verdict. Neither situation existed in the case.
First, applying In re Uni-Marts, LLC, 404 B.R. 767 (Bankr. D. Del. 2009), the court found that Garavelas was not essential to Service Painting’s reorganization. This situation arises when the “non-debtor must divert ‘critical management resources from the reorganization effort to litigation.’” Garavelas presented no evidence that would show why his defense of the litigation would divert substantial resources.
Second, the court noted that courts in the Third Circuit will extend the automatic stay to non-debtors when the debtor owes them indemnification obligations under either a binding agreement or statutory or common law authority forcing indemnification. The court then cited precedent holding that the indemnitee’s liability typically must arise from his performance of his duties as an employee of the debtor. Thus, in the case at hand, extension of the automatic stay was not warranted. Not only had Garavelas failed to show any indemnification obligations, but he was being sued in his individual capacity for breaching fiduciary duties that he individually owed to the Funds. A judgment against him therefore would not, in effect, be a judgment against Service Painting, and the court declined to extend the automatic stay to Garavelas.
The court also rejected Garavelas’s argument that the court should extend the automatic stay because a judgment against him would be preclusive in Services Paintings’ bankruptcy. The court listed the elements of collateral estoppel: (1) an identity of issues; (2) a final judgment on the merits; (3) a party or privity in the prior adjudication; and (4) a full and fair opportunity to litigate.
Garavelas argued that collateral estoppel would apply against Service Paintings even though it was not a party to the ERISA case because its interests would be “adequately represented” in that proceeding. However, a mere “alignment of interests alone does not warrant application of collateral estoppel to a non-party. The party seeking application of collateral estoppel must show the party in the earlier proceeding must understand he is ‘acting in a representative capacity’ for the non-party.” Initially, the court noted that it could “only speculate as whether a judgment against Garavelas would preclude Service Painting in future litigation,” particularly given that Garavelas failed to offer evidence of any indemnification obligations that might support application of collateral estoppel. Additionally, it explained that a future court likely would not find that Garavelas adequately represented Service Painting in the ERISA case due to his failure to make a “vigorous defense” in that proceeding. Thus, the court concluded that extending the automatic stay would unduly “interfere with creditors’ enforcement of their rights against non-debtor co-defendants.”
Conclusion
Accordingly, and for other reasons stated in its opinion, the court rejected Garavelas’s arguments and declined to extend the automatic stay to protect him from the Funds’ ERISA action.
In re Fed-Mogul Glob., Inc., 300 F.3d 368 (3d Cir. 2002)
Background
Tens of thousands of individuals (the Plaintiffs) brought personal injury and wrongful death claims in state courts around the United States for asbestos-related injuries from certain “friction products,” such as brake pads (referred to as Friction-Product Claims). The Plaintiffs alleged exposure through the manufacture, repair, installation, and use of brake pads and other products, which caused them to develop mesothelioma and other diseases. Federal-Mogul Global and 156 affiliated entities (the Debtors) were defendants in many of these suits and filed for chapter 11 relief in Delaware on October 1, 2001, resulting in a stay of the state court proceedings against them.
Several other companies who were also defendants in friction-product cases (the Non-Debtor Defendants) attempted to remove many of their cases to the appropriate federal district courts and moved to transfer them to Delaware. They argued that the Delaware District Court had related-to jurisdiction over the Friction-Product Claims against them because they had obtained some of the friction products they used from the Debtors and, therefore, would be entitled to indemnification or contribution from the Debtors.
The District Court granted a provisional transfer of the Friction-Product Claims against the Non-Debtor Defendants, but ultimately denied a permanent transfer and remanded the claims. The District Court held that it lacked subject-matter jurisdiction over the Friction-Product Claims based on the Third Circuit’s opinion in Pacor Inc. v. Higgins (In re Pacor), 743 F.2d 984 (3d Cir. 1984), that “related-to bankruptcy jurisdiction [does] not extend to a dispute between non-debtors unless that dispute, by itself, creates at least the logical possibility that the estate will be affected.” However, a dispute between third parties is, “[a]t best . . . a mere precursor to the potential third party claim for indemnification” against the estate. The District Court therefore concluded that the Friction-Product Claims did not, by themselves, give rise to a possibility that the estate would be effected because (1) any judgment on the claims would not bind the Debtors and (2) the Non-Debtor Defendants’ potential indemnification claims against the Debtors had not yet accrued.
Analysis
The Non-Debtor Defendants appealed the District Court’s ruling. They argued that “the various claims against them could lead to substantial indemnification or contribution claims against Federal-Mogul, which would in turn significantly affect the administration of the bankruptcy estate and the development of an appropriate plan of reorganization.” Thus, focusing on Pacor’s articulation of the test for related-to jurisdiction as “whetherthe outcome of that proceeding could conceivably have any effect on the estate being administered in bankruptcy,” they emphasized that “the outcome of the Friction Product Claims could conceivably have an effect on Debtors’ estate, because it is ‘conceivable’ that if the Friction Product Plaintiffs succeed in their claims against them, the Friction Product Defendants would seek indemnification and/or contribution from Federal-Mogul.” (Emphasis in original.)
The Non-Debtor Defendants also argued that the Sixth Circuit’s decision in Lindsey v. O’Brien Tanski, Tanzer & Young Health Care Providers of Connecticut(In re Dow Corning), 86 F.3d 482 (6th Cir. 1996), which distinguished Pacor, should control in mass tort situations. The Dow Corning court held that the district court had related-to jurisdiction over thousands of silicone-implant claims against non-debtors because the claims were so numerous that the non-debtors’ contingent indemnification claims against Dow Corning would affect the size of the estate and the length of the case. For the same reasons, the Dow Corning court distinguished Pacor, which involved only one potential indemnification claim: “A single possible claim for indemnification or contribution simply does not represent the same kind of threat to a debtor’s reorganization plan as that posed by the thousands of potential indemnification claims at issue here.”
The Third Circuit upheld the District Court’s decision. The court rejected the defendants’ focus on the word “conceivable” in Pacor because, despite the opinion’s “seemingly broad language,” it rejected the possibility that related-to jurisdiction exists where “the allegedly related lawsuit would [not] affect the bankruptcy proceeding without the intervention of yet another lawsuit.” Thus, related-to jurisdiction did not exist in Federal-Mogul because the Non-Debtor Defendants’ claims against the Debtors “have not yet accrued and would require another lawsuit before they could have an impact on Federal-Mogul’s bankruptcy proceeding.”
The Third Circuit also agreed with the District Court that Dow Corning’s analysis to distinguish Pacor was unpersuasive. The District Court had “regard[ed] with misgiving the proposition that mere numbers of claims should prevail over articulable principles when it comes to defining federal subject matter jurisdiction.” The District Court had also distinguished Dow Corning for the reasons stated in Arnold v. Garlock, Inc., 278 F.3d 426 (5th Cir. 2001):
In [Dow Corning], each of the co-defendants was closely involved in using the same material, originating with the debtor, to make the same, singular product, sold to the same market and incurring substantially similar injuries. This circumstance created a unity of identity between the debtor and the co-defendants not present here, where the co-defendants variously use asbestos for brake friction products, insulation, gaskets, and other uses.
Conclusion
Accordingly, and for other reasons stated in its opinion, the Third Circuit denied the Non-Debtor Defendants’ request to compel transfer of the Friction-Products Claims.
Dunaway v. Purdue Pharms. L.P. (In re Purdue Pharms. L.P.), 619 B.R. 38 (S.D.N.Y. 2020)
Background
In Purdue, the Debtors and various non-debtors, including Purdue’s former or current owners, directors, officers, and other associated entities (collectively, the Related Parties), were subject to more than 2,600 governmental enforcement actions and private lawsuits in state and federal courts (collectively, the Opioid Actions), alleging that Purdue’s manufacture, promotion, and sale of prescription painkillers contributed to the ongoing opioid crisis.
The Debtors therefore sought and obtained a preliminary injunction enjoining all of the Opioid Actions against the Debtors and their Related Parties, including Purdue’s former president and co-chairman, non-debtor Dr. Richard Sackler, whose family has controlled a majority of Purdue’s stock for generations. The Debtors had argued that continuation of the Opioid Actions, and Purdue’s continued defense of the same, “[would] eviscerate the fundamental goals of these bankruptcy cases” and cause the value of their estates to be “rapidly eroded by the staggering direct and indirect costs of [the] litigation.” Indeed, Purdue claimed to owe potential indemnification obligations to its current and former directors and officers, including Dr. Sackler. Further, the claims against the Related Parties were “based on conduct substantially identical to, and inextricably intertwined with, that alleged to have been engaged in by the Debtors.” Thus, the injunction was necessary, inter alia, both to preserve the Debtors’ bankruptcy estates and to prevent the Opioid Actions from resulting in findings of fact or law that would, “at a minimum, create an adverse record against the Debtors.”
Five district attorneys and a private plaintiff (the Appellants) in Dunaway, et al. v. Purdue Pharma L.P. (the Dunaway Action) appealed. In the Dunaway Action, the Appellants sought damages from Purdue and Dr. Sackler, among others. The Appellants asked the District Court to vacate the injunction as to their claims against Dr. Sackler.
Analysis
Jurisdiction
The Appellants argued, inter alia, that the Bankruptcy Court lacked related-to jurisdiction over the Dunaway Action. For several reasons, the District Court rejected the Appellants’ argument.
The District Court explained that “[a] bankruptcy court has ‘related to’ jurisdiction over every case where ‘the action’s outcome might have any conceivable effect on the bankrupt estate.’” Under the conceivable effects test, Second Circuit precedent teaches that “when one tortfeasor files for bankruptcy, any action against their co-tortfeasors for the same conduct falls within the bankruptcy court’s ‘related to’ jurisdiction” because the plaintiff “can only proceed on [its] claims if it establishes that the [debtor’s misconduct] occurred.” Based on the Appellants’ pre-petition complaint against Purdue and Dr. Sackler, the District Court concluded that they could not pursue their allegations against Dr. Sackler without implicating Purdue. These interrelated allegations established related-to jurisdiction even if there was no identity of interests between Purdue and Dr. Sackler. The Bankruptcy Court therefore was correct to exercise jurisdiction over the Dunaway Action.
However, the District Court also agreed with the Debtors’ argument that their alleged indemnification obligations to Dr. Sackler also established related-to jurisdiction. The Appellants asked the District Court to apply the Third Circuit’s test for related-to jurisdiction, which requires an evidentiary record establishing that the third-party dispute may “affect the bankruptcy without the intervention of another lawsuit.” (Emphasis in original.) According to the Appellants, Dr. Sackler’s contingent indemnification claim [was] ‘untested,’” and Purdue’s board had not committed to honoring its indemnification obligations. The Appellants therefore “argued that “without a more rigorous ‘legal standard that requires an evidentiary foundation for invoking a bankruptcy court’s jurisdiction,’ the Debtors’ application of the ‘conceivable effects’ test ‘improperly expands the bankruptcy forum from a court of limited jurisdiction’ to allow it ‘to suspend any dispute in any forum anywhere in the country that conceivably affects a debtor,’” including purely third-party opioid litigation merely involving theories of liability similar to those asserted against Purdue.
The District Court stated that although the Third Circuit’s test “may be a wise policy, it is not the law in the Second Circuit. Courts in this Circuit have embraced neither an elevated evidentiary standard nor proof of ‘automatic liability’ as prerequisites for the bankruptcy court’s exercise of ‘related to’ jurisdiction.” The District Court was therefore satisfied that it was not required to reach the merits of Dr. Sackler’s potential indemnification claim or determine whether he would prevail on that claim to determine whether the Dunaway Action would have a conceivable effect in the Debtors’ bankruptcy cases. Rather, the District Court was satisfied that the Dunaway Action could lead to a fight over the scope of Purdue’s indemnification obligations, and “[t]he mere fact that such a dispute is conceivable is enough to confer jurisdiction on the Bankruptcy Court.” The estate would bear the cost of litigating that dispute, which would satisfy the Second Circuit’s conceivable effects test.
Further, the District Court was unconcerned with the Appellants’ “slippery slope” argument. In particular, the District Court disagreed that there was a risk that opioid litigation involving other non-debtors might become subject to the Bankruptcy Court’s injunction. Critically, litigation not involving Purdue, or its Related Parties would not require “proving facts that would also prove Purdue’s own liability” or result in indemnification or contribution claims against the Debtors. Thus, “this opinion does not amend or extend the outer bound of the conceivable effects test: the jurisdiction of the bankruptcy court remains ‘limited to actions that create contingent obligations against the estate.’”
Injunction Pursuant to Section 105(a)
The District Court also addressed the parties’ arguments concerning whether the Bankruptcy Court abused its discretion in ordering the preliminary injunction. Much of the dispute focused on whether there was a likelihood of a successful reorganization. However, the District Court also focused on whether the preliminary injunction was necessary to prevent irreparable harm to the estate and whether the public interest weighed in favor of issuing the injunction.
The District Court answered both questions in the affirmative. First, it agreed that the estate would suffer irreparable harm because, inter alia, “the Dunaway Action, if allowed to proceed against Dr. Sackler alone, ‘would embarrass, burden, delay or otherwise impede the debtor’s estate and reorganization prospects.’” Indeed, “[i]t would certainly embarrass Purdue for one of its largest shareholders and former leaders to be found culpable for the opioid epidemic.” Second, although the District Court agreed with the Bankruptcy Court that there was a public interest in transparency that would be served by allowing the Dunaway Action to proceed, thereby requiring Dr. Sackler to “answer for his personal role in the opioid epidemic in Tennessee.” However, both courts also concluded that the balance of hardships favored the Debtors, because the injunction “does not destroy Appellants’ interest in transparency. It does not immunize Dr. Sackler against personal liability, and it does not protect him from having to disclose details about his personal wealth.” Rather, “there will be transparency as to what happened here upon confirmation of a plan and thereafter.” Thus, “[t]he balance of the hardships and the public interest favor leaving the injunction in place.”
Conclusion
Accordingly, and for other reasons stated in its opinion, the District Court affirmed the Bankruptcy Court’s orders entering (and extending) the preliminary injunction.
11 U.S.C. § 362
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of–
(1) The commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;
. . . .
11 U.S.C. § 105
(a) The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.
Authority Summaries for Question 2
Spyglass Media Grp., LLC v. Bruce Cohen Prods. (In re Weinstein Co. Holdings, LLC), 997 F.3d 497 (3d Cir. 2021)
Background
In September 2011, Bruce Cohen and his production company entered into an agreement (the Cohen Agreement) with SLP Films, Inc. (SLP), a special purpose entity formed by The Weinstein Company (TWC) to make the film Silver Linings Playbook. The Cohen Agreement was structured as a work-made-for-hire contract where Cohen, himself, owned none of the intellectual property in the film. In exchange for the production, SLP agreed to pay Cohen $250,000 in fixed compensation, as well as contingent future compensation based on the film’s net profits. The film was a success, and soon after its release, TWC, through the dissolution of the other owning entity, ended up with full rights to the film.
Nonetheless, in March 2018, after the Harvey Weinstein scandal unfolded, TWC filed for chapter 11 relief and sought the Bankruptcy Court’s approval of a sale of the business to Spyglass Media Group, LLC under section 363 of the Bankruptcy Code. The sale closed in July 2018, but provided Spyglass with a four-month cushion (until November 2018) to designate which of TWC’s executory contracts it wanted to assume as part of the sale. Spyglass believed the Cohen Agreement was not an executory contract at all and filed a declaratory judgment action against Cohen seeking a determination that the Cohen Agreement was not executory and thus already part of the sale to Spyglass. In November 2018, additional writers, producers, and actors with similar work-made-for-hire contracts “hitched their wagon to the Cohen dispute and argued that their contracts are also executory.” If the work-made-for-hire contracts were executory, Spyglass would have been responsible for millions of dollars in contingent compensation to each work-made-for-hire contract formed with TWC.
In January 2019, the Bankruptcy Court issued a bench ruling concluding that the Cohen Agreement was not an executory contract and thus could be sold to Spyglass under section 363. The District Court affirmed the Bankruptcy Court’s decision, and Cohen appealed.
Analysis
Before exploring the parties’ arguments, the court discussed the general premises underlying the Bankruptcy Code’s provisions governing the assumption and rejection and executory contracts. On one extreme, “a contract where the debtor fully performed all material obligations, but the nonbankrupt counterparty has not . . . can be viewed as just an asset of the estate with no liability.” Such a contract should not be treated as executory because doing so “risks inadvertent rejection” of an asset. On the other extreme, “where the counterparty performed but the debtor has not, the contract . . . is only a liability for the estate.” Such a contract should not be treated as executory because doing so “risks inadvertent assumption” of a liability that should instead be treated as a mere unsecured claim. Only “where there can be uncertainty if the contract is a net asset or liability for the debtor” should it be treated as executory and therefore subject to assumption or rejection and the requirement to cure existing defaults before assumption. That requirement, the court noted, “is motivated by fairness to the nonbankrupt counterparty, as assuming the contract essentially provides a ‘means whereby a debtor can force others to continue to do business with it when the bankruptcy filing might otherwise make them reluctant to do so.’”
Next, the court discussed the specific legal principles governing executory contracts. It cited the Countryman Test, pursuant to which a contract is executory if, under applicable state law, each party to the contract has at least one material unperformed obligation as of the petition date. New York law governed the Cohen Agreement, and therefore New York law governed whether both TWC and Cohen each owed at least one obligation thereunder that would give rise to a material breach if not performed. The court explained that New York law defines as a material breach the failure to do something that is so fundamental to the contract that such failure defeats the essential purpose of the contract, but that it also applies the “substantial performance” rule, which provides that “[i]f the party in default has substantially performed, the other party’s performance is not excused.” The Third Circuit characterized these rules as “two sides of the same coin,” because “if it is determined that a breach is material, or goes to the root or essence of the contract, it follows that substantial performance has not been rendered.”
Spyglass’s primary argument that the Cohen Agreement was not an executory contract capable of being assumed and assigned was that the “root” purpose of the contract had been substantially performed. Cohen made two key arguments in response. First, he argued that he owed outstanding material obligations that would give rise to a material breach if not performed. Second, he argued that where parties have contracted around the substantial performance rule by agreeing that an obligation is material, a court should not substitute its own judgment.[3]
Despite acknowledging that Cohen’s arguments were “forceful,” the court ultimately affirmed the Bankruptcy Court’s and District Court’s decisions and held that the Cohen Agreement was not an executory contract.
First, in determining whether there were outstanding material obligations on both sides of the Cohen Agreement, the court held that TWC’s obligation to pay contingent compensation to Cohen was clearly material. However, the court determined that Cohen’s remaining obligations were not material because they did not go to the “root of the contract” or “defeat the purpose of the entire transaction” if breached. Cohen’s only remaining obligations were to refrain from seeking injunctive relief about the exploitation of the movie and to indemnify TWC against third-party claims arising from the breach of his representations and warranties (most of which had surpassed the statute of limitations). Thus, only TWC owed material unperformed obligations under the Cohen Agreement.
Second, in looking at whether the Cohen Agreement was executory on its face, the court found that the parties here did not clearly and unambiguously avoid the substantial performance rule for evaluating executory contracts. The court stated that the language included in the Cohen Agreement was merely a condition—that TWC must pay the contingent compensation if Cohen is “not otherwise in breach or default”—which, unlike a duty, cannot render a contract executory for purposes of section 365. Further, it noted that all of Cohen’s citations involved courts deferring to parties’ agreements concerning the materiality of specific contract terms that were expressed through remedies or termination provisions. This was a “meaningful distinction,” the court stated, because “[w]hen parties say that breach of a provision would result in termination or rescission of the contract, they make clear that the provision is material.” In contrast, “covenants address the parties’ obligations . . . and typically are not a natural place to look when determining which of those obligations the parties consider to be material.” (Emphasis in original.)
Finally, the court also explained that if it accepted Cohen’s argument, then the Cohen Agreement would be executory forever, no matter how much of the contract had been performed. This, the court stated, “would contravene the protections created for debtors by the bankruptcy code.” Thus, the court concluded, “the Bankruptcy Code views the Cohen Agreement as a non-executory contract that is in essence a liability for the Debtors that can be sold to Spyglass . . . without the need to cure existing defaults.”
Conclusion
As such, the Third Circuit concluded that any contingent compensation owed to Cohen under the Cohen Agreement before its sale to Spyglass could only be asserted as an unsecured claim.
Gen. DataComm Indus., Inc. v. Arcara (In re Gen. DataComm Indus., Inc.), 407 F.3d 616 (3d Cir. 2005)
Background
In 1997, General DataComm Industries Inc. entered into a benefit agreement with certain long-term senior executives (the Benefit Plan), under which DataComm would fund two forms of insurance benefits for these executives: (1) long-term care insurance coverage for the lifetime of each eligible executive and his spouse; and (2) upon retirement, for each eligible executive and his spouse, a lifetime continuation of health insurance benefits. The Benefit Plan listed certain actions which, if taken by an eligible executive, would lead to the loss of all benefits under the Benefit Plan, including violating any confidentiality agreement, disclosing any proprietary information, refusing to cooperate with DataComm in litigation, directly or indirectly becoming employed by a competitor, or bringing suit against DataComm (the Restrictive Covenants). Four of the eligible executives (the Executives) brought this suit.
In November 2001, DataComm filed for relief under chapter 11 of the Bankruptcy Code. Soon after, DataComm advised the Executives—all of whom were at retirement age, but had yet to retire—that they would be terminated on November 30, 2001, and that the Benefit Plan would be terminated on that same date. The day before their termination, DataComm moved to reject the Benefit Plan. The Executives objected, claiming that the Benefit Plan qualified for treatment under section 1114 of the Bankruptcy Code as insurance benefits to retired employees because their termination was a “forced retirement.” The Bankruptcy Court agreed and denied DataComm’s motion to reject the Benefit Plan. The District Court affirmed.
Analysis
The court was confronted with two questions: (1) whether the Executives constituted “retired employees” for the purposes of invoking the protections of section 1114, and (2) if so, whether the Benefits Plan could be rejected pursuant to section 365.
Addressing the first question, DataComm argued that section 1114 didn’t apply because the Executives had not retired at the time of the motion to reject the Benefit Plan. The Third Circuit rejected this argument on fairness grounds, stating that accepting the argument when DataComm had fired the Executives the day after filing its motion would “contravene[] basic norms of fairness and undermines the purposes of [section] 1114, which ‘was enacted to protect the interests of retirees of [c]hapter 11 debtors.’” The Third Circuit also agreed with the District Court that DataComm should not be permitted to escape its obligations under the Benefit Plan by arguing that the Executives were terminated without cause rather than retired, given that “the intent of both DataComm and the [Executives] was that the [Executives] would receive the retirement benefits of the [Benefit] Plan unless they were terminated for cause.” (Emphasis added.) In reaching this conclusion, the court relied on a citation to the “prevention doctrine,” which stated that “[w]here a promisor prevents, hinders, or renders impossible the occurrence of a condition precedent to his or her promise to perform, or to the performance of a return promise, the promisor is not relieved of the obligation to perform.” For these and other reasons, the court held that section 1114, not section 365, controlled.
In a concurring opinion, Judge Pollak disagreed with the court’s reliance on the prevention doctrine and stated that the prevention doctrine can do no more than return the parties to the situation that existed prior to the Executives’ dismissal. Because the Executives had not yet retired when DataComm sought to terminate the agreement, the prevention doctrine should not have changed the outcome even if it applied. It would merely reinstate the Executives as employees who had not yet gained the protections of section 1114.
Addressing the second question, the court was satisfied that the Benefit Plan was executory. The court recited the definition of an executory contract as “a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.” However, the court concluded that while state law defines what constitutes a material breach, the parties had agreed that the Executives’ Restrictive Covenants were material obligations through a provision allowing DataComm to terminate the Executives’ benefits if they breached the Restrictive Covenants. The court therefore declined to engage in a materiality analysis, deferring to the parties’ agreement. However, because the Executives were protected under section 1114, DataComm could not reject the Benefit Plan even if it were executory.
Judge Pollak again disagreed, concluding that the plan was not executory. Rather than deferring to the parties’ agreement that the Restrictive Covenants were material, he applied Delaware state law, under which the materiality test set forth in the Restatement (Second) of Contracts controls.[4] The “defining feature” of the Restatement’s five-factor test is “the connection between materiality and consideration,” such that “one party’s obligation [will be deemed] material where it serves as consideration for the other party’s promised performance.”[5] Thus, stating that “a party’s obligation to perform or forbear will be material if it functioned as consideration, or as the reason inducing the other party’s entry into the contract,” Judge Pollak concluded that the Restrictive Covenants were not material. Indeed, the Executives’ “forbearance is not what motivate[d] or compensate[d] DataComm’s performance. Instead, the [Benefit] Plan memorialized a promise by DataComm to furnish its long-standing executives with certain benefits.” He also relied on Third Circuit precedent holding that “while ‘a contracting party’s failure to fulfill a condition excuses performance by the other party whose performance is so conditioned, it is not, without an independent promise to perform the condition, a breach of contract subjecting the nonfulfilling party to liability for damages.’” The Restrictive Covenants were conditions, Judge Pollak reasoned, not duties, because while breach would excuse DataComm’s performance, it would not subject the Executives to liability for damages.
Judge Pollak therefore joined in the court’s judgment—but not its reasoning—that DataComm could not reject the Benefit Plan.
Conclusion
The Third Circuit affirmed both the Bankruptcy Court and District Courts decisions—even though the Benefit Plan was an executory contract, the Executives were “retired employees” within the meaning of section 1114. Thus, the Benefit Plan could not be rejected.
In re Sea Oaks Country Club, LLC, Ch. 11 Case No. 20-17228, 2020 WL 6588412 (Bankr. D.N.J. 2020)
Background
Sea Oaks Country Club, LLC (the Country Club) and Sea Oaks Golf Club, LLC (the Golf Club) filed for chapter 11 relief on June 3, 2020 with the ultimate goal of seeking the Bankruptcy Court’s approval of a section 363 sale to Atlantic Homes, Inc. Atlantic Homes was a 49 percent owner of both the Country Club and the Golf Club and held a claim against the Debtors in the amount of $10,440,342.50.
Sea Oaks Country Club, L.L.P. (the LLP) was a predecessor of the Debtors. The LLP had constructed, owned, and operated the Golf Club and the Country Club. When first opened, the LLP advertised lifetime golf memberships (the Lifetime Memberships), which offered benefits such as no greens fees, preferential tee times, complimentary golf cart use, discounts on merchandise, and other amenities. In addition to these benefits, the Lifetime Membership certificates stated that they were “irrevocable and shall continue in perpetuity.” To obtain a Lifetime Membership, the members would pay a lump sum of $50,000 or $60,000.
After the Debtors filed bankruptcy, they filed a motion for an order (1) approving the sale of their assets free and clear of liens, claims, and encumbrances; (2) authorizing the assumption and assignment of certain executory agreements and leases; and (3) rejecting other executory agreements and leases and all membership agreements. The third form of relief requested was the subject of the relevant part of this opinion.
Certain parties (the Lifetime Members) filed an objection to any sale that would allow the Debtors to reject their Lifetime Memberships. They primarily argued that (1) they had fully performed their obligations with respect to the Lifetime Memberships when they made their upfront, lump-sum payment and (2) because the Lifetime Memberships were irrevocable, they were not executory contracts and could not be rejected under section 365 of the Bankruptcy Code.
In response, the Debtors argued that the Lifetime Memberships were executory contracts subject to rejection under section 365 because the Lifetime Members had continuing obligations to keep their accounts current and act in accordance with the rules and regulations of the Country Club and the Golf Club.
Analysis
The court explained that the Third Circuit defines an executory contract as “a contract under which the obligation of both the bankrupt and the other party to the contract are so far underperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.” Further, the court explained that unless both parties had unperformed obligations that would give rise to a material breach if not performed (as determined pursuant to applicable state law), a contract is not executory.
Based on this definition, the court found that both the Debtors and the Lifetime Members had unperformed obligations. On the one hand, the Debtors still were obligated to maintain and provide access to the golf course and its amenities. On the other hand, the Lifetime Members still were required to settle their accounts for any purchases of merchandise or food, they were prohibited from defacing club property, and they were obligated to comply with scheduled tee times and rules of play. However, the main question was whether these obligations were material.
The Lifetime Members relied on a New Jersey Supreme Court case, Ross Systems v. Linden Dari-Delite, 173 A.2d 258 (1969), pursuant to which, they argued, a breach is only material if it goes to the essences of the contract and allows the non-breaching party to actually terminate the contract. The court rejected this interpretation of Ross Systems, and instead clarified that in addition to determining whether the breach goes to the essence of the contract, to be material, the breach must also allow the non-breaching party to treat the contract as terminated and refuse to render continued performance.
As the Lifetime Members’ obligations “[c]ertainly” went to the essence of the contract, the court reasoned that while the Debtors might not be able to terminate the Lifetime Memberships, they must have had some redress for a material breach by a Lifetime Member. That redress included terminating the Debtors’ own performance obligations, which established that the Lifetime Members’ obligations were material.
Conclusion
The court held that because both parties had mutual unperformed obligations that were material under New Jersey state law, the Lifetime Memberships were executory contracts that could be rejected by the Debtors.
11 U.S.C. § 365
(a) Except as provided in sections 765 and 66 of this title and in subsections (b), (c), and (d) of this section, the trustee, subject to the court’s approval, may assume or reject any executory contract or unexpired lease of the debtor.
(b) (1) If there has been a default in an executory contract or unexpired lease of the debtor, the trustee may not assume such contract or lease unless, at the time of assumption of such contract or lease, the trustee–
(A) cures, or provides adequate assurance that the trustee will promptly cure, such default other than a default that is a breach of a provision relating to the satisfaction of any provision (other than a penalty rate or penalty provision) relating to a default arising from any failure to perform nonmonetary obligations under an unexpired lease of real property, if it is impossible for the trustee to cure such default by performing nonmonetary acts at and after the time of assumption, except that if such default arises from a failure to operate in accordance with a nonresidential real property lease, then such default shall be cured by performance at and after the time of assumption in accordance with such lease, and pecuniary losses resulting from such default shall be compensated in accordance with the provisions of this paragraph;
(B) compensates, or provides adequate assurance that the trustee will promptly compensate, a party other than the debtor to such contract or lease, for any actual pecuniary loss to such party resulting from such default; and
(C) provides adequate assurance of future performance under such contract or lease.
11 U.S.C. § 1114
(a) For purposes of this section, the term “retiree benefits” means payments to any entity or person for the purpose of providing or reimbursing payments for retired employees and their spouses and dependents, for medical, surgical, or hospital care benefits, or benefits in the event of sickness, accident, disability, or death under any plan, fund, or program (through the purchase of insurance or otherwise) maintained or established in whole or in part by the debtor prior to filing a petition commencing a case under this title.
. . . .
(e) (1) Notwithstanding any other provision of this title, the debtor in possession, or the trustee if one has been appointed under the provisions of this chapter (hereinafter in this section “trustee” shall include a debtor in possession), shall timely pay and shall not modify any retiree benefits, except that–
(A) the court, on motion of the trustee or authorized representative, and after notice and a hearing, may order modification of such payments, pursuant to the provisions of subsections (g) and (h) of this section, or
(B) the trustee and the authorized representative of the recipients of those benefits may agree to modification of such payments, after which such benefits as modified shall continue to be paid by the trustee,
after which such benefits as modified shall continue to be paid by the trustee.
Authority Summaries for Question 3
Stewart v. Holland Acquisitions, Inc., Civ. No. 15-01094, 2021 WL 1037617 (W.D. Pa. Mar. 18, 2021)
Background
On February 4, 2021, Holland Acquisitions, Inc., filed a chapter 7 bankruptcy petition. Shortly thereafter, it filed a suggestion of bankruptcy in a pre-petition Fair Labor Standards Act (FLSA) action that had been filed against it by the Department of Labor. The Department had accused the Debtor of repeatedly and deliberately violating the FLSA by failing to fairly compensate its employees. Thus, it sought not only to recover back wages and liquidated damages for the Debtor’s injured employees, but also “an equitable judgment . . . permanently enjoining and restraining any future FLSA violations by [the Debtor].”
The issue before the court was whether the Department’s action was subject to the automatic stay, or whether the police powers exception applied under section 362(b)(4). The Debtor argued that the police powers exception did not apply to the Department’s action because the Department sought relief protecting the rights of private individuals. In contrast, the Department argued that its action served to “promote public policy by enforcing a remedial statute” and that the relief it sought related “principally to the government’s public policy interest in the general welfare of the employees.” Therefore, it asserted, the police powers exception did apply.
Analysis
Initially, the court noted that the Third Circuit applies two “overlapping and complementary tests” to determine “whether the [Department’s] action advances [its] ‘police or regulatory power’ such that the exception to the automatic stay would be triggered.” The first test is the “pecuniary purpose test,” focusing on “whether the government primarily seeks to protect a pecuniary governmental interest in the debtor’s property, as opposed to protecting the public safety and health.” The second test is the “public policy test,” focusing on “whether the government is effecting public policy rather than adjudicating private rights.”
Agreeing with the Department, the court concluded that to stay an FLSA action for back wages and liquidated damages, “hand in hand with prospective injunctive relief,” would “substantially impair the core remedial purposes of the FLSA.” Indeed, based on section 362(b)(4)’s legislative history, actions to fix damages for the violation of police or regulatory laws, and for issuance and enforcement of an injunction, were intended to be excepted from the automatic stay. Further, the FLSA was “exactly the type of remedial statute intended to advance public safety and welfare as well as promote a public policy that goes to concerns beyond only the payment of wages earned and payable by statute to one or more discrete individuals.”
In rejecting the Debtor’s position—and its citation to the Sixth Circuit’s decision in an analogous case, Chao v. Hosp. Staffing Servs., Inc., 270 F.3d 374 (6th Cir. 2001)—the court admitted that “it is true that successful litigation by the [Department] will often result in the award of backpay and liquidated damages to workers who had been deprived of legally mandated compensation (and that could be one outcome here).” However:
[A] key purpose of even those lawsuits is to bring a culpable employer into compliance with the FLSA going forward. The award of what may turn out to be sizeable money damages is intended to foster that result. And more than that, the possibility of prospective injunctions and the award of ancillary backpay and liquidated damages serves to deter others from failing to fulfill their wage-payment duties under the FLSA, and to signal to the marketplace the critical importance of employers’ compliance with that vital federal statute.
(Emphasis added.) Thus, to characterize the Department’s lawsuit as one seeking only to “ascertain the rights of a private individual and obtain judgment for that individual’s benefit” would “inaccurately minimize[] both the litigation role of the [Department] under the FLSA and the purposes of such litigation.” The court instead concluded that “while there would be a monetary benefit to workers deprived of earned compensation if the [Department] prevails in this case, the principal role of the [Department] in maintaining this lawsuit is to vindicate the public policy central to the FLSA.”
Conclusion
The court therefore held that the Department’s action was excepted from the automatic stay and allowed it to proceed, expressly disagreeing with the Sixth Circuit’s decision and reasoning in Chao.
Hospital Staffing Services, Inc. (HSSI) was a company in the business of providing home health care and other health-related services to patients primarily in Tennessee and New England. While HSSI relied on Medicare and insurance, the majority of HSSI’s revenue came from a secured revolving loan agreement with Capital Healthcare Financing (CHF). In March 1998, HSSI filed a petition for chapter 11 reorganization in the Bankruptcy Court for the Southern District of Florida. HSSI was able to stay afloat for almost a year during the reorganization due to a court-approved $8,000,000 loan from CHF.
Despite this loan, HSSI failed to reorganize and converted its bankruptcy to a chapter 7 liquidation. A chapter 7 trustee (the Trustee) was appointed. The Department of Labor subsequently filed an action under the Fair Labor Standards Act (the FLSA) in the United States District Court for the Western District of Tennessee (the District Court). The Department contended that certain of the Debtor’s records were “hot goods,” i.e., that they had been produced in violation of the FLSA, because the Debtor did not pay approximately 600 employees during its last weeks in operation. The Department sought an injunction barring the Trustee from transporting the records across state lines and obtained a preliminary injunction from the District Court directing him to deposit the amount necessary to clear the hot goods designation.
The Trustee needed the Debtor’s records to bill its patients and seek Medicare reimbursements. Accordingly, he appealed to the Sixth Circuit, disputing the District Court’s jurisdiction over the Department’s FLSA action and the allegedly hot goods.[6] In particular, the Trustee disagreed with the District Court’s conclusion that the police powers exception to the automatic stay applied to the action under section 362(b)(4).
Analysis
The Trustee presented two arguments. First, if the Department obtained a money judgment, it would improperly elevate the unpaid workers’ claims from administrative expenses to super-priority claims. Second, the Trustee argued that the Department’s suit would disrupt the Bankruptcy Code’s equitable distribution scheme and interfere with the Bankruptcy Court’s jurisdiction. The Department maintained, inter alia, that the District Court was correct to exercise jurisdiction over its FLSA action based on the police powers exception to the automatic stay.
The court agreed with the Trustee’s jurisdictional argument. While the automatic stay protects bankruptcy court jurisdiction subject to the police powers exception, among others, the Department’s action did not pass the public policy test as required under section 362(b)(4). Instead, the court concluded that the Department’s action primarily benefited private individuals.
The court’s reasoning was influenced by caselaw recognizing that the FLSA “reflects Congress’[s] desire to eliminate the competitive advantage enjoyed by goods produced under substandard conditions” and protects interstate commerce from being made “the instrument of competition in the distribution of goods produced under substandard labor conditions, which competition is injurious to the commerce.” Thus, FLSA actions brought “to protect legitimate businesses from unfair competition and to enforce the federal law regarding minimum wage” will fall within the police powers exception.
However, “[t]he existence of the public policy test naturally presumes that some suits by governmental units, even though they would effectuate certain declared public policies, will nevertheless be regarded as largely in furtherance of private interests.” Therefore, “when the action incidentally serves public interests but more substantially adjudicates private rights, courts should regard the suit as outside the police power exception, particularly when a successful suit would result in a pecuniary advantage to certain private parties vis-a-vis other creditors of the estate, contrary to the Bankruptcy Code’s priorities.” Even though such an action can “punish wrongdoers and thereby provide a general deterrent to unfair labor practices,” it may still not pass the public policy test if it “serves little public purpose other than a general interest in seeing laws enforced.”
The court concluded that the Department’s hot goods action against the Trustee primarily benefited the Debtor’s unpaid workers. Indeed, the “significant public interest in protecting other businesses from unfair competition [was] not present because the ‘goods’ [were] merely records relating to services already rendered by employees.” The goods would not be sold in interstate commerce, therefore the Department’s suit would not prevent unfair competition or protect “other workers in the economy” whose livelihoods would be “threatened by the introduction of [such] goods into the national economy.” Rather, the action was “merely a vehicle to enforce the private rights of the employees to the minimum portion of their wages Congress guaranteed.”
Conclusion
Accordingly, the court held that the police powers exception did not apply. The Bankruptcy Court therefore had exclusive jurisdiction and the District Court should have dismissed the Department’s FLSA action. Notably, however, a dissenting opinion suggested that the majority’s discussion improperly narrowed the scope of the public policy test.
11 U.S.C. § 362
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—
(1) The commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;
. . . .
(b) The filing of a petition under section 301, 302, or 303 of this title, or of an application under section 5(a)(3) of the Securities Investor Protection Act of 1970, does not operate as a stay—
. . .
(4) under paragraph (1), (2), (3), or (6) of subsection (a) of this section, of the commencement or continuation of an action or proceeding by a governmental unit or any organization exercising authority under the Convention on the Prohibition of the Development, Production, Stockpiling and Use of Chemical Weapons and on Their Destruction, opened for signature on January 13, 1993, to enforce such governmental unit’s or organization’s police and regulatory power, including the enforcement of a judgment other than a money judgment, obtained in an action or proceeding by the governmental unit to enforce such governmental unit’s or organization’s police or regulatory power;
. . . .
Authority Summaries for Question 4
Cal. Coast Univ. v. Aleckna (In re Aleckna), 13 F.4th 337 (3d Cir. 2021)
Background
The Debtor, a former student at California Coast University, filed for chapter 13 relief in 2012 and subsequently asked for a copy of her transcript from the University. The University provided her with an incomplete copy that did not list her graduation date, explaining that because she still owed approximately $6,300 in unpaid tuition, she was not considered to have graduated. The University then filed a non-dischargeability complaint against the Debtor for the tuition.
The Debtor responded with a counterclaim for damages under section 362(k) of the Bankruptcy Code, asserting that the University had willfully violated the automatic stay of acts to collect pre-petition debts in violation of section 362(a)(6) by refusing to provide her with a complete transcript. The University eventually withdrew the non-dischargeability action with prejudice, but still refused to provide the Debtor with a complete transcript.
The Bankruptcy Court agreed with the Debtor. Analogizing to providing an unsigned letter of reference, the Bankruptcy Court concluded that providing the Debtor with an incomplete transcript was tantamount to providing no transcript at all. Accordingly, the Bankruptcy Court found that the University had willfully violated the automatic stay and awarded the Debtor nominal damages and substantial attorneys’ fees.
The University appealed, asserting a defense to willful stay violations under the Third Circuit’s decision in University Medical Center v. Sullivan (In re University Medical Center), 973 F.2d 1065 (3d Cir. 1992). University Medical held that a party does not “willfully” violate the automatic stay if “the law governing the alleged violation was ‘sufficiently uncertain.’” The University argued that existing case law was ambiguous as to whether it would have violated the automatic stay not to provide the Debtor with a complete copy of her transcript. The District Court rejected the University’s argument because it failed to cite any persuasive authorities holding that its conduct would not have violated the automatic stay, and affirmed the Bankruptcy Court’s order.
The University then appealed to the Third Circuit, conceding that it violated the automatic stay, but maintaining, inter alia, that University Medical provided it with a defense.
Analysis
The Third Circuit affirmed. Initially, it engaged in a thorough analysis to confirm that University Medical was not legislatively overruled when the relevant provision of section 362 to provide that “an individual who commits a willful violation is liable for damages and attorneys’ fees unless ‘such violation is based on an action taken by an entity in the good faith belief’ that the stay had terminated due to the debtor’s failure to file a timely notice of intention.”
The Third Circuit then explained why it agreed with the District Court that University Medical did not shield the University from liability. The University had failed to establish a defense under University Medical because it relied on the purported absence of any authorities holding that its conduct violated the automatic stay, rather than citing authorities affirmatively establishing that its conduct did not violate the automatic stay. Indeed, “a lack of case law to the contrary does not render the law sufficiently unsettled under University Medical.” Instead, to establish a defense under University Medical, “[a] defendant must point to authority that reasonably supports its belief that its actions were in accordance with the stay.”
Conclusion
Accordingly, the Third Circuit rejected the University’s defense under University Medical, among other arguments, and affirmed the District Court’s order.
City of Chicago v. Fulton, 141 S. Ct. 585 (2021)
Four Debtors whose vehicles had been impounded by the City of Chicago pre-petition for unpaid fines asserted that the City’s post-petition refusal to return their vehicles violated the automatic stay of acts to obtain possession of or exercise control over property of the estate under section 362(a)(3). The Bankruptcy Court and Seventh Circuit ruled in favor of the Debtors, finding that merely continuing pre-petition possession or control of property of the estate violated subsection (a)(3).
Interpreting the plain language of subsection (a)(3), the Supreme Court reversed on appeal. The Supreme Court held that “the most natural reading” of the words “stay,” “act,” and “exercise control,” as used in subsection (a)(3), prohibited affirmative acts that would disturb the status quo as of the petition date. Indeed, “the language of § 362(a)(3) implies that something more than merely retaining power is required to violate the disputed provision.”
However, the Supreme Court expressly limited its holding to subsection (a)(3), stating that it could not “definitively rule out” the Debtors’ interpretation of the words used therein and admitting that, “as [the Debtors] point out, omissions can qualify as ‘acts’ in certain contexts.” Thus, in a concurring opinion, Justice Sotomayor wrote separately to emphasize that “the Court has not decided whether and when § 362(a)’s other provisions may require a creditor to return a debtor’s property,” citing to a Seventh Circuit decision holding that a university’s refusal to provide a transcript to a debtor violated the automatic stay of acts to collect pre-petition debts under subsection (a)(6).
Margavitch v. Southlake Holdings, LLC (In re Margavitch), Adv. No. 20-00014, 2021 WL 4597760 (M.D. Pa. Oct. 6, 2021)
Background
On December 17, 2019, Anthony Margavitch, Jr., filed for bankruptcy under chapter 13. Before filing for bankruptcy, Margavitch had been sued by Southlake Holdings, LLC, through its loan servicing agent Auburn Loan Servicing, Inc. (collectively, the “Defendants”). Southlake had obtained a judgment and filed a praecipe for writ of execution against Penn East Federal Credit Union as garnishee. Margavitch owned funds in two Penn East accounts that were subject to attachment as of the petition date. Through their respective counsel, Margavitch asked the Defendants to discontinue the attachment because it was a violation of the automatic stay. The Defendants disagreed and refused to withdraw the attachment.
On February 10, 2020, Margavitch commenced an adversary proceeding alleging, inter alia, that the Defendants violated subsections (a)(1) through (a)(6) of the automatic stay.[7] The parties filed cross-motion for summary judgment and, at the court’s request, supplemental briefings following the Supreme Court’s decision in City of Chicago v. Fulton, 141 S. Ct. 585 (2021). Fulton had held that an affirmative act to change the status quo was required to violate the automatic stay of acts to obtain possession of or exercise control over property of the estate under section 362(a)(3), rejecting the position that merely continuing pre-petition possession or control was a violation. Margavitch asserted that Fulton was inapplicable, arguing that its holding was limited to cases involving possession of tangible property, whereas the Defendants did not have physical possession of any of the Debtor’s property. The Defendants argued that they took no affirmative actions after the petition date, and that even though Fulton was limited to section 362(a)(3), it should be applied to the other subsections of the automatic stay.
Analysis
The court, applying Fulton, found that the Defendants did not violate the automatic stay by refusing to withdraw the valid state court pre-petition attachment on the Debtor’s accounts. The court reasoned that the Defendants’ only affirmative acts occurred pre-petition, whereas their post-petition acts were better characterized as inactions to preserve the status quo as of the petition date. Thus, rejecting the Debtor’s attempt to distinguish Fulton because the Defendants did not have physical possession of the Debtor’s funds, the court held that the Defendants did not violate subsection (a)(3) of the automatic stay by refusing to withdraw the attachment.
The court also held that Fulton should be applied to subsections (a)(4), (5), and (6) of the automatic stay because they all begin with the phrase “any act to . . . .” Thus, because the Defendants did not take any affirmative act post-petition, they did not violate the automatic stay of acts to create, perfect, or enforce a lien or collect a pre-petition debt.
Next, the court held that the Defendants did not violate subsection (a)(1), which stays the commencement or continuation of judicial, administrative, or other actions or proceedings against Debtors. Citing In re Iskric, 496 B.R. 335 (Bankr. M.D. Pa. 2013), the Debtor argued that the Defendants violated subsection (a)(1) because they did not affirmatively act to avoid violating the automatic stay. Iskric held that a creditor violated the automatic stay by allowing the continuation of a proceeding that ultimately resulted in a bench warrant and incarceration of the Debtor. The court distinguished Iskric because it was “an example of a factual scenario where if a creditor has put a process into effect that, without intervention, causes a change in the status quo as to property of the estate or the Debtor, then a creditor must act to avoid that change of the proceeding in that case changed the status quo.” In contrast, continuation of the attachment in Margavitch did not change the status quo and the Defendants did not continue to pursue the garnishment process.
Finally, the court held that the Defendants did not violate subsection (a)(2), which stays acts to enforce a pre-petition judgment. The court reasoned that the mere passive maintenance of the pre-petition attachment could not be construed as an affirmative act to enforce a judgment post-petition and did not change the status quo.
Conclusion
Finding that Fulton controlled as to subsection (a)(3) and should be extended to the other subsections of the automatic stay, the court held that the Defendants did not commit the alleged stay violations because they did not take any affirmative post-petition acts to change the status quo.
Cordova v. City of Chicago (In re Cordova), Ch. 13 Case No. 19-06255, Adv. No. 19-00684, 2021 WL 5774400 (Bankr. N.D. Ill. Dec. 6, 2021)
Background
Between 2016 and 2019, several residents (the Plaintiffs) of the City of Chicago had their vehicles impounded by the City for unpaid fines. After the vehicles were impounded, each of the Plaintiffs filed for bankruptcy under chapter 13. The Plaintiffs requested release of the impounded vehicles, but the City refused unless the Plaintiffs paid upfront fees and treated its claims as fully secured in their respective bankruptcy cases. The Plaintiffs subsequently filed a putative class action complaint against the City asserting, inter alia, violations of the automatic stay under subsections (a)(4), (a)(6), and (a)(7).[8]
The City filed a motion to dismiss, arguing, inter alia, that Fulton’s affirmative act requirement should be extended to the other subsections of the automatic stay. The Plaintiffs argued that Fulton only applies to section 362(a)(3) and that they sufficiently alleged claims under the remaining subsections.
Analysis
The court declined to extend Fulton to the other subsections of the automatic stay because “(a) Fulton is limited by its own terms to section 362(a)(3) and thus retention of the vehicles may still be a stay violation; (b) [t]he City may have committed other acts in violation of the automatic stay; and (c) [t]he City’s interpretation leaves debtors with virtually no immediate remedy . . . at all.” The court relied on Justice Sotomayor’s concurring opinion in Fulton that there were clear limitations to the Supreme Court’s ruling and that only section 362(a)(3) contained the phrase “to exercise control.” The court then cited the majority ruling in Fulton, which recognized that omissions or inactions combined with other facts could qualify as acts under the other subsections of the automatic stay.
Thus, the court concluded that there were “plausible readings” of the subsections of the automatic stay other than subsection (a)(3) that did not “preclude the Plaintiffs’ Complaint.” The court proceeded to analyze whether the Plaintiffs had stated claims under those subsections.
Section 362(a)(4)
Acts to “create, perfect, or enforce any lien against property of the estate” violate the automatic stay under subsection (a)(4). The court questioned “whether the City’s continued possession is an act to create, perfect, or enforce that lien” because it was undisputed that the vehicles were property of the Plaintiffs’ estates. The court therefore denied the City’s motion to dismiss as to this claim because the Plaintiffs plausibly alleged that by continuing to retain their vehicles, the City may have acted to perfect its liens on their vehicles under the possessory-lien ordinance pursuant to which the City’s liens arose.
Section 362(a)(6)
Acts to “collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title” violate the automatic stay under subsection (a)(6). The court questioned whether the City’s holding of the vehicles amounted to an “act to collect, assess, or recover a claim” because it was undisputed that the City had pre-petition claims against the Plaintiffs. The court therefore denied the City’s motion to dismiss as to this claim, not only because the City had demanded payment of fees as a condition of release, but because the City’s possessory-lien ordinance allowed third-party lienholders to obtain release of the Debtors’ vehicles by paying only the City’s towing costs. In contrast, the Debtors were required to pay all of their outstanding fines. This suggested to the court that the City’s refusal to release the Debtors’ vehicles was designed to compel them to pay the City’s claims.
Section 362(a)(7)
“[T]he setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor” violates the automatic stay under subsection (a)(7). In addition to the other requirements for setoff, the court stated that the City must have intended any setoff to be permanent in order to violate the automatic stay under this subsection. The court therefore granted the City’s motion to dismiss as to this claim because the Debtors had not alleged any facts suggesting that the City had intended a permanent setoff by retaining possession of their vehicles. However, it allowed the Debtors to amend their complaint because it could “hypothesize a set of facts consistent with the allegations of the Complaint that might establish the requisites for a claim under section 362(a)(7).”
Conclusion
Accordingly, and for other reasons stated in its opinion, the court declined to extend the Supreme Court’s ruling in Fulton to the other subsections of the automatic stay and largely denied the City’s motion to dismiss.
11 U.S.C. § 362
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—
. . .
(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title;
. . . .
. . . .
(k) (1) Except as provided in paragraph (2), an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.
(2) If such violation is based on an action taken by an entity in the good faith belief that subsection (h) applies to the debtor, the recovery under paragraph (1) of this subsection against such entity shall be limited to actual damages.
See also Phila. Newspapers, 407 B.R. at 611 (noting that “[c]ourts have often conflated” the second and third parts of the analysis, but explaining that “each step of the inquiry is distinct, independently necessary, and implicates different interests” because section 105(a) is neither a source of jurisdiction, nor a “repository of any substantive rights,” and instead empowers the bankruptcy court to issue injunctions as necessary to carry out the other provisions of the Bankruptcy Code). ↑
The elements of collateral estoppel include that “(1) the issue decided in the prior case is identical to the one presented in the later case; (2) there was a final judgment on the merits in the prior action; (3) the party against whom collateral estoppel is asserted was a party to the prior action, or is in privity with a party to the prior action; and (4) the party against whom collateral estoppel is asserted had a full and fair opportunity to litigate the issue in the prior action.” ↑
In addition to the two parties’ arguments, the Producers Guild of America, Inc. (the PGA) filed an amicus brief asserting one additional argument in support of Cohen. The PGA explained that in this field producers place reliance on the ongoing materiality of specific provisions within these types of agreements. Any deviation from recognizing and enforcing these provisions would undermine the intent of the parties and threaten the viability of both the contracts and the production of the movies they support. ↑
The Restatement’s test is also controlling under Pennsylvania state law. E.g., Gamesa Energy USA, LLC v. Ten Penn Ctr. Assocs., L.P., 217 A.3d 1227, 1231 (Pa. 2019). ↑
The factors of the test include “(a) the extent to which the injured party will be deprived of the benefit which he reasonably expected; (b) the extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived; (c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture; (d) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances; [and] (e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.” Restatement (Second) of Contracts § 241 (Am. Law Inst. 1981). ↑
The Trustee also moved the Bankruptcy Court to assert jurisdiction over the Debtor and all of its assets to the exclusion of the District Court. The Bankruptcy Court determined that the Department had engaged in forum shopping, and that the District Court had interfered with the Bankruptcy Court’s exclusive jurisdiction over the Debtor’s estate because the Department’s suit was merely an action to collect a debt rather than an exercise of police power. However, the Bankruptcy Court declined to enter an order and instead referred the case to the United States District Court for the Southern District of Florida. ↑
Southlake later withdrew the attachment after Margavitch obtained confirmation of a chapter 13 plan providing for payment of Southlake’s claim in full. ↑
The Plaintiffs had amended the complaint after issuance of the Supreme Court’s decision in City of Chicago v. Fulton, 141 S. Ct. 585 (2021), to remove a cause of action under subsection (a)(3). ↑
This past March, the U.S. Department of Housing and Urban Development (“HUD”) announced it was simultaneously rescinding its 2020 discriminatory effects rule (the “2020 Rule”) and reinstating its 2013 rule (the “2013 Rule”) under the Fair Housing Act. Curiously, in reinstating the 2013 Rule and rescinding the 2020 Rule, HUD reinstated the old rule almost verbatim—failing to adequately consider the U.S. Supreme Court’s ruling in Tex. Dep’t of Hous. & Cmty. Affairs et al. v. Inclusive Communities Project, Inc., et al., which was instrumental in HUD’s development of the 2020 Rule. (See “HUD Restores 2013 Discriminatory Effects Rule” for additional background information.) This merry-go-round of events has left several industries in a lurch, with the homeowner’s insurance industry the latest victim.
As background, a decade ago, concurrent with the above timeline, two industry trade associations that primarily represent the interests of members that sell homeowner’s insurance challenged the 2013 Rule before the U.S. District Court for the District of Columbia (the “D.C. Court”) as exceeding HUD’s authority. In 2014, the D.C. Court held that disparate impact claims are impermissible under the Fair Housing Act and vacated HUD’s 2013 Rule. See American Insurance Assn. v. HUD, 74 F.Supp.3d 30, 46-47 (D.D.C. 2014). However, the D.C. Court also noted that, at least with regards to disparate impact claims, it anticipated that the Supreme Court would further clarify the matter in Inclusive Communities (which, at the time, was pending). Id. at 47.
Sure enough, just months later in Inclusive Communities, the Supreme Court held that disparate impact claims are cognizable under the Fair Housing Act. 576 U.S. 519, 545–546. Subsequently, the D.C. Circuit Court vacated the D.C. Court ruling and remanded the case for consideration in light of Inclusive Communities. In response to the Supreme Court’s ruling, the insurance industry changed tack in its amended complaint—arguing that, while disparate impact claims may be cognizable under the Fair Housing Act, the 2013 Rule still exceeds the parameters the Supreme Court laid out in Inclusive Communities.
Fast forward to today. Nearly a decade later, in Nat’l Assn. of Mutual Insurance Companies v. HUD, et al., the D.C. Court has ultimately determined that, post-Inclusive Communities, the reinstated 2013 Rule does not conflict with the Fair Housing Act as applied to insurers’ underwriting and rating practices. 2023 WL 6142257, *1 (D.D.C. 2023).
In summarizing the meandering course of events over the previous decade, the D.C. Court said:
[In] a period covering three Presidential administrations—the Disparate-Impact Rule [i.e., the 2013 Rule] was substantially overhauled, then stayed, then revived to its original form. Along the way, one of the two associations dropped out of the action, leaving the National Association of Mutual Insurance Companies (“NAMIC”) as the only plaintiff. The good news for NAMIC is that its challenge is, at long last, ripe for decision. The bad news for NAMIC is that its post–Inclusive Communities arguments for invalidating the . . . Rule, creative as they might be, are unconvincing. Indeed, because I have concluded that the Rule does not conflict with the Fair Housing Act as applied to insurers’ underwriting and rating practices, I must DENY NAMIC’s motion for summary judgment and GRANT HUD’s cross-motion for summary judgment.
Id.
First, the D.C. Court reiterated that the 2013 Rule still expressly applied to providers of homeowner’s insurance, which is why the trade associations initially brought action against HUD, arguing that the Fair Housing Act only prohibited intentional discrimination—thus, HUD’s “[2013] Rule recognizing disparate-impact liability exceeded [HUD’s] statutory jurisdiction, authority, and limitations. Id. at *2. The D.C. Court also said that, while it originally agreed with the trade associations, the Supreme Court ultimately held that disparate impact claims are cognizable under the Fair Housing Act, but with the caveat that disparate impact liability should not “displace valid governmental and private priorities.” Id. at 3.
In quoting key parts of Inclusive Communities, the D.C. Court said:
For one, at the prima facie stage of the analysis, “a disparate-impact claim that relies on a statistical disparity must fail if the plaintiff cannot point to a defendant’s policy or policies causing that disparity.” Id. at 542 (emphasis added). This “causality requirement” is “robust”: a mere statistical correlation is insufficient, and external factors that might limit a defendant’s discretion can sever the causal connection between a housing practice and any disparate impact. Id. at 542–43. If a prima facie case is met, it is a defense to a disparate-impact claim if a housing practice or policy is proven to be “necessary to achieve a valid interest.” Id. at 541. In the final calculus, housing practices or policies “are not contrary to the disparate-impact requirement unless they are ‘artificial, arbitrary, and unnecessary barriers.’” Id. at 543 (quoting Griggs v. Duke Power Co., 401 U.S. 424, 431 (1971)).
Id. at *3 [emphasis in original].
Second, in summarizing the short-lived 2020 Rule, the D.C. Court recognized that it made things more difficult “for plaintiffs to advance disparate-impact claims and easier for defendants to justify housing practices and policies so as to avoid liability.” Id. Naturally, this upset fair housing groups, which challenged the 2020 Rule and obtained a preliminary injunction postponing its effective date. Id. In the interim, the new Presidential administration (i.e., the Biden administration), announced its opposition to the 2020 Rule (which was promulgated under the Trump administration), and “by June 2021, HUD issued a Notice of Proposed Rulemaking with plans ‘to recodify its previously promulgated rule.’” Id. at *4. The D.C. Court also noted that, “[a]ccording to HUD, the 2013 Rule ‘better states Fair Housing Act jurisprudence and is more consistent with the Fair Housing Act’s remedial purposes.’” Id.
Finally, in analyzing HUD’s reinstated 2013 Rule—but through the lens of Inclusive Communities—the D.C. Court reiterated that the disparate impact standard has been restated verbatim. Id. Consequently, NAMIC has been forced to change its strategy, arguing in its amended complaint that the 2013 Rule still conflicts with the Fair Housing Act, but in more nuanced ways. Id. at *8. In reviewing each of NAMIC’s more nuanced arguments, the D.C. Court noted that, while they likely would have been convincing before Inclusive Communities, it must ultimately reject all of them. Id. at *9–12.
However, the D.C. Court appears to suggest in its analysis that the 2013 Rule—which was reinstated verbatim without considering Inclusive Communities—may still provide plaintiffs with too much leeway to second-guess a defendant’s legitimate business decisions, and this would likely conflict with the parameters laid out by the Supreme Court. Consequently, while it is uncertain NAMIC will appeal, this case (or one like it) may ultimately end up at the Supreme Court.
Given that HUD reinstated its 2013 Rule with barely a consideration for Inclusive Communities, it should come as no surprise that the “re-litigation of dead issues” is causing headaches for the insurance industry. Other industries should anticipate the same, as more courts and regulatory agencies reexamine HUD’s 2013 Rule to determine how it fits within the Inclusive Communities framework.
The decline in Canadian equity financings and rising interest rates have prompted strategic changes among Canadian public companies. Faced with funding challenges and escalating borrowing costs, more reporting issuers are considering going-private transactions. This shift offers opportunities for foreign strategic buyers interested in acquiring depressed-valued Canadian public company targets.
This article provides an overview of Canadian going-private transactions and outlines key considerations for foreign strategic buyers and target companies.
Private Equity Considerations
Declining markets prompt foreign strategic buyers, like private-equity (PE) funds, to seek acquisition opportunities where a target’s market value misaligns with its perceived value. PE funds view going private as an opportunity to lower costs, enhance operational strategies, shield from market pressures, and reduce regulatory obligations. Enhanced operational flexibility and the freedom to enact changes without immediate market scrutiny increase the perceived value of going private. PE funds typically structure transactions as a leveraged buy-out (LBO) with debt backed by the target’s assets to maximize returns, securing control with minimal capital investment.
In some cases, insiders initiate going-private transactions. Target management (a Management Buyout) or existing security holders may seek to take the company private. For Management Buyouts, often backed by a PE fund, the board must manage potential conflicts.
A. Structuring the Transaction
Structuring a going-private transaction requires diligent planning and analysis. The three common structures are take-over bids followed by second-step transactions, amalgamations, or court-sanctioned arrangements. Each approach has benefits, challenges, and regulatory requirements.
1. Take-Over Bids
A take-over bid refers to an offer aimed at acquiring a target company’s outstanding voting or equity securities within a Canadian jurisdiction. This offer is directed at one or more security holders. If the securities involved, combined with those already owned or controlled by the offeror, equal 20 percent or more of the class, it qualifies as a take-over bid. The rules and disclosure obligations are primarily outlined in Part 2 of National Instrument 62-104 – Take-Over Bids and Issuer Bids (NI 62-104).
For a take-over bid, NI 62-104 mandates creating and distributing a written offer to purchase and a take-over bid circular to all eligible security holders of the target company. In response, the directors of the target company are required to produce their own circular, endorsing or opposing the bid. The nature of this recommendation depends on whether the bid is negotiated or unsolicited. A negotiated take-over bid (a friendly bid) garners endorsement of the target company and often is facilitated through a definitive acquisition agreement adhering to relevant securities laws. Unsolicited bids (hostile bids) involve direct offers to security holders, potentially circumventing the target company’s board.
The conclusion of a take-over bid occurs upon the bid’s expiration and the successful acquisition and payment for the securities tendered by security holders. Considering the possibility of incomplete tendering, a second-step transaction (statutory squeeze-out or business combination) is often necessary to secure the remaining securities. The structure of the second step will depend on the percentage of controlled securities by the offeror after the bid expires. If over 90% of the class’s outstanding securities are tendered in the bid, the offeror can effect the acquisition of the remaining securities through a statutory squeeze-out. If the threshold is not met, a business combination may be used to force out the remaining security holders of the target company at the same price and under the same terms that were offered under the initial bid.
2. Amalgamation
Another option is through an amalgamation. The foreign buyer establishes a wholly owned Canadian subsidiary that amalgamates with the target. Following the amalgamation, security holders of the target company typically receive redeemable securities in the newly formed entity, which are swiftly redeemed for cash. The buyer then has control over the amalgamated entity, which then continues the operations of the former publicly traded company.
Corporate regulations require a shareholder meeting to approve the amalgamation. Approval from security holders who own a minimum of two-thirds of the outstanding voting securities must be secured, either in person or via proxy. Moreover, the applicability of MI 61-101 – Protection of Minority Security Holders in Special Transactions (NI 61-101) could necessitate majority approval from minority security holders, unless an exemption is applicable.
3. Plan of Arrangement
A plan of arrangement is commonly used for going-private transactions in Canada. This court-approved process involves negotiations between the foreign buyer and the target company’s board or special committee. The parties will negotiate an arrangement agreement to outline terms, followed by two court appearances.
The initial appearance includes the target company’s application for an interim order, which governs procedural aspects such as convening and notifying the special meeting of security holders, as well as stipulating approval thresholds for each class. The subsequent appearance, which follows the special meeting approval, seeks a final order confirming the arrangement’s equity and rationality.
Distinguishing itself from a take-over bid, a plan of arrangement allows the buyer to secure all outstanding voting securities of the target within a single transaction, sidestepping the need for a second-step acquisition or a business combination. This structure offers agility in managing distinct security classes as compared to other methods, providing the potential to encompass asset divestitures, spinouts, or other restructuring matters, facilitating efficient structuring and strategic tax planning.
B. Key Considerations
1. Exclusivity
As the strategic buyer will need to expend significant resources to negotiate the transaction, it will seek exclusive engagement with the target company for a predetermined period to conduct comprehensive due diligence, secure financing commitments, and finalize terms while shielding from competing offers.
Negotiating exclusivity involves balancing the buyer’s needs and target board’s fiduciary duties. The most buyer-friendly approach is a no-shop provision restraining the target from exploring alternatives. Public company directors must consider how this affects their fiduciary duties. No-shop provisions usually include a fiduciary out, allowing the board to consider superior unsolicited bids. A window-shop provision is more balanced and allows the target to consider any unsolicited bids, even if they are not superior to the existing bid.
Go-shop provisions allow the target to actively seek third-party offers for limited periods. Go-shop provisions are used less frequently in Canada and are limited to transactions involving PE funds or where a limited market assessment has been conducted upfront. While favoring the target, foreign buyers may accept these clauses to reduce litigation risk. In cases of third-party offers, a potential foreign buyer may seek a matching right to counter preferred bids. Crafting these provisions requires balance considering fiduciary obligations and each party’s negotiating position.
2. Conflicts of Interest and Fiduciary Duties
In a going-private transaction, the directors, officers, and affiliates of the target company may be the acquirer of the target company. This scenario poses numerous potential conflicts of interest due to the fiduciary responsibilities of these parties. Where a conflict exists, MI 61-101 mandates an independent special committee be formed for oversight, enhanced disclosure, and minority shareholder consent. An impartial valuation may also be required and summary of the report provided in the disclosure documentation to verify the value of the target.
While not mandatory under Canadian law, the target company should consider whether it/the special committee requires its own impartial financial and legal advisor to assist with a fairness opinion to assess transaction terms. This assists in demonstrating the board met its fiduciary duties when approving the transaction.
3. Litigation Risk
Litigation risks in going-private deals, especially from minority holders challenging fairness or fiduciary breaches, underscore the need for transparent processes and conflict prevention. An independent director special committee, even if not mandated, offers protection against conflicts of interest and threats from minority security holders for misrepresentations or inadequate disclosure.
4. Enhanced Disclosure Obligations
Depending on the transaction, MI 61-101 may impose additional disclosure obligations. For instance, related-party take-over bids must include: (i) prior two-year valuations of the target company, (ii) relevant past offers in the two years before the deal, (iii) target board and special committee review process, (iv) relied-upon exemptions from MI 61-101 valuation rules, (v) any material disagreement between the target company’s board and the special committee, (vi) the number of votes that will be excluded to determine whether minority approval is obtained, and (vii) the identity of security holders who are excluded from the minority approval vote and their individual holdings.
5. Regulatory Matters
Foreign strategic buyers must navigate the Investment Canada Act (ICA) and its regulations on foreign investments. The ICA aims to ensure that non-Canadian investments contribute to Canadian economic growth and employment. When a foreign buyer gains control of a Canadian target, it may trigger an ICA notification or review. Notifications, simpler and less costly than reviews, require the foreign buyer to submit basic transaction details within thirty days of closing. If a foreign buyer’s acquisition meets financial thresholds and faces ICA review, they must prove to the Minister of Innovation, Science, and Economic Development that the investment benefits Canada. This assessment considers: (i) the impact on economic activity; (ii) the degree of Canadian involvement; (iii) the effects on productivity, technology, and innovation; (iv) the influence on industry competition; (v) policy alignment; and (vi) enhancement of Canada’s global competitiveness.
Conclusion
Going-private transactions restore operational flexibility by minimizing exposure to market volatility and regulatory constraints, but challenges persist. Foreign buyers, including PE funds, must select optimal structures carefully and manage many aspects of the transaction, including exclusivity concerns, conflicts of interest, litigation risk, disclosure, and regulatory considerations. The parties must weigh potential value creation against the complexities of transitioning to a private entity. Optimal planning and execution are crucial to harnessing the full potential of these transactions.
Following the publication of a draft multicurrency facility term sheet including a sustainability-linked loan appendix by the Asia Pacific Loan Market Association (APLMA) in the last quarter of 2022, on February 17, 2023, the Loan Syndications and Trading Association (LSTA) issued drafting guidance for sustainability-linked loans, to provide drafting examples of provisions related to sustainability-linked loans for a U.S.-style syndicated credit agreement.[1]
On February 22, 2023, the LSTA, the APLMA, and the Loan Market Association (LMA) jointly issued updated versions of the Guidance on Sustainability-Linked Loan Principles (SLLP),[2]Guidance on Green Loan Principles (GLP),[3] and Guidance on Social Loan Principles (SLP).[4] Each of the Guidances should be read alongside the respective updated principles SLLP,[5] GLP,[6] and SLP.[7] Although these are suggested market-standard frameworks, it is recommended by the loan bodies that loan transactions completed prior to March 9, 2023, should continue to follow the original positions under the relevant guidelines and principles relating to SLLP, GLP, and SLP and that all loans originated, extended, or refinanced after March 9, 2023, should fully align with the relevant guidelines and principles of SLLP, GLP, and SLP as amended by the 2023 updates.
The LSTA, APLMA, and LMA had previously jointly issued the latest version of Guidance for Green, Social and Sustainability-Linked Loans External Reviews in March 2022,[8] which is a voluntary guidance on professional and ethical standards for external reviewers for circumstances where external review providers are appointed to undertake external reviews in connection with entering into and executing green loans, social loans, or sustainability-linked loans. The purpose of that update was to align with the guideline on the same topic issued by the International Capital Market Association (ICMA) in the previous year.
These regular updates by loan industry bodies covering Europe, Asia Pacific, and the United States show a growing trend toward standardizing loan terms with respect to green loans, social loans, or sustainability-linked loans by providing a harmonized recommended framework for credit market players to encourage borrowers to contribute to sustainability from an environmental, social, and governance (ESG) perspective. Alignments made with ICMA guidelines also show the intention to promote consistency across debt (bond and loan) markets.
Green Loans and Social Loans: Key Changes in 2023
The amended 2023 GLP, SLP, and SLLP and their respective guidances provide more articulation of the characteristics of green loans, social loans, and sustainability-linked loans. To distinguish between a green loan and a social loan, the fundamental determinant is the utilization of the loan proceeds for green projects or social projects. Besides the key determinant of use of proceeds, the other core criteria set out in the respective GLP or SLP principles must also be met; these criteria are generally related to project evaluation and selection, management of proceeds, and reporting.
Green loans are any type of loan instruments and/or contingent facilities (such as bonding lines, guarantee lines, or letters of credit) made available exclusively to finance, refinance, or guarantee, in whole or in part, new and/or existing eligible green projects. The key changes to the 2023 GLP include the following:
The loan industry bodies provided a list of examples of eligible green project categories to capture common types of projects supported by the green loan market, such as (but not limited to) renewable energy (including production, transmission, appliances, and products); energy efficiency (such as in new and refurbished buildings, energy storage, district heating, smart grids, appliances, and products); pollution prevention and control; climate change adaptation; green buildings; and clean transportation projects.
With respect to the process for project evaluation and selection, borrowers are encouraged to have a process in place to identify mitigants to known or potential material risks of negative project impacts.
With respect to management of proceeds, the borrower should attest to that in a formal internal process linked to the borrower’s lending and investment operations for green projects, and the borrower should let lenders know of any intended types of temporary placement for the balance of unallocated proceeds.
Social loans are categorized as any type of loan instruments and/or contingent facilities that are made available exclusively to finance, refinance, or guarantee, in whole or in part, new and/or existing eligible social projects and that are aligned to the core components of the SLP with respect to the use of proceeds, the process for project evaluation, and selection and reporting. It is recommended that borrowers explain the alignment of their social loan with the SLP in their legal documentation. The key changes to the 2023 SLP include the following:
The SLP provides nonexhaustive categories for eligible social projects and explicitly recognizes several broad categories of eligibility for social loans with the objective of addressing key social purposes, such as affordable basic infrastructure, access to essential services, and affordable housing.
There is emphasis on the requirement for transparency, accuracy, and integrity of disclosure of information reported by borrowers to stakeholders through the core components of the SLP.
Similar to project evaluation and selection of green project loans, borrowers are encouraged to have a process in place to identify mitigants to known or potential material risks of negative project impacts with respect to the process for project evaluation and selection.
Similar to the management of proceeds of green project loans, the borrower should attest to the management of proceeds in a formal internal process linked to the borrower’s lending and investment operations for green projects, and the borrower should let lenders know of any intended types of temporary placement for the balance of unallocated proceeds.
Sustainability-Linked Loans: Key Changes in 2023
In terms of sustainability-linked loans, one should not make a determination based on the use of proceeds to determine the sustainability-linked loan’s categorization but should rather focus on whether the loan supports a borrower in improving its sustainability performance, through meeting (or not meeting) predetermined sustainability performance targets. The amended SLLP guide provides that sustainability-linked loans are any types of loan instruments and/or contingent facilities for which the economic characteristics can vary depending on whether the borrower achieves ambitious, material, and quantifiable predetermined sustainability performance objectives. Therefore, proceeds under a sustainability-linked loan could be used to finance any kind of business activities that the borrower is pursuing—for example, it could finance a project that overlaps under a green/social loan or an acquisition transaction.
The table below summarizes examples of recommendations in the SLLP as amended in 2023:
Core Components
Recommended Standards
Selection of KPIs
Sustainability key performance indicators (KPIs) must be material to the borrower’s core sustainability and business strategy and address relevant ESG challenges of its industry sector.
The KPIs must be
relevant, core, and material to the borrower’s overall business, and of high strategic significance to the borrower’s current and/or future operations;
measurable or quantifiable on a consistent methodological basis; and
able to be benchmarked (it is recommended that an external reference or definitions should be used as much as possible to facilitate use of the KPI to assess the sustainability performance target’s level of ambition).
A key change in 2023 included that the calculation methodology with respect to the KPIs provided by the borrower should follow international standards and science-based methodologies where available. The SLLP guidance provides clarification on what “material” KPIs mean.
Calibration of SPTs
The sustainability performance targets (SPTs) must be set in good faith and remain relevant as applicable and ambitious throughout the life of the loan. Furthermore, such targets should
represent a material improvement in the respective KPIs and be beyond both a “business as usual” trajectory and regulatory required targets;
be compared to a benchmark or an external reference where possible;
be consistent with the borrower’s overall sustainability strategy; and
be determined on a predefined timeline, set before or concurrently with origination of the loan.
A key change in 2023 included that an annual SPT be set per KPI for each year of the loan term. The borrower should also take competition and confidentiality considerations into account and flag any strategic information that may decisively impact the achievement of the SPTs.
Loan Characteristics
An economic outcome is linked to whether the selected predefined SPTs are met. For example, the margin under the relevant loan agreement will often be reduced where the borrower satisfies a predetermined SPT as measured by the predetermined KPIs and vice versa.
The key change for this component is with respect to cases where a strong rationale is provided; the margin ratchet may include a neutral bracket in which no margin adjustment applies.
Reporting
On information covenants, besides encouragement to publicly report SPT-related information and details of SPT calculation and assumption methodologies, borrowers should provide the lenders participating in the loan with the following information at least once per annum:
up-to-date information sufficient to allow participating lenders to monitor the performance of the SPTs and to determine that the SPTs remain ambitious and relevant to the borrower’s business; and
(as a key amendment) a sustainability confirmation statement with a verification report attached, outlining the performance against the SPTs for the relevant year and the related impact, and timing of such impact, on the loan’s economic characteristics.
Verification
To verify the performance of KPIs and SPTs, borrowers must obtain independent and external verification of their performance level against each SPT for each KPI. Such verification is an important element of the SLLP and should be conducted by a qualified external reviewer with relevant expertise, such as an auditor by way of limited or reasonable assurance, environmental consultant, and/or independent ratings agency.
A key change relating to verification obligations is that such obligations should be for any date or period relevant for assessing the SPT performance leading to a potential adjustment of the sustainability-linked loan economic characteristics, and they should continue until after the last SPT trigger event of the loan has been reached. Also, such verification of performance must be shared with lenders in a timely manner and be made publicly available where appropriate.
Recent Leading Market Example
In Canada, FortisBC Energy Inc. (FortisBC) recently announced on its company website that it incorporated SPTs to establish a market-leading sustainability-linked credit facility with the Canadian Imperial Bank of Commerce (CIBC) as administrative agent, sole book runner, sole lead arranger, and sole sustainability structuring agent.[9] The Canadian market welcomed this news, which was shared by various media platforms on the internet, because this is reputedly the first time that a natural gas Canadian utility incorporated a customer emissions target into its credit facility with financial institutions—and, moreover, such credit facility included SPTs related to Indigenous participation on a project basis, which we understand is still highly uncommon in Canada.
According to publicly available disclosures, fees under FortisBC’s sustainability-linked credit facility were tied to and may be adjusted based upon two SPTs relating to the environment and Indigenous participation:
annual greenhouse gas (GHG) emissions reduced through renewable and low carbon gas displacing conventional natural gas volumes, lowering customers’ GHG emissions; and
increased focus on projects with meaningful and equitable Indigenous participation.
FortisBC will be able to obtain favorable pricing adjustments on its credit facility if it makes progress in these SPTs, and we look forward to following the journey of FortisBC and CIBC in their respective ESG contributing roles.
Conclusion
With the recent 2023 updates on green loans, social loans, and sustainability-linked loans by various loan bodies, there is an expectation in the market about the importance of leading financial institutions and their key role of encouraging borrowers to join the sustainability movement. Money is not the only metric in the funding market, and if environmental and social impact metrics are done right to allow lenders to support their clients in achieving their sustainability/ESG goals, the sustainable future that both sides are committed to pursuing may provide a longer-lasting positive impact internationally.
