Bay Area Bankruptcy Forum Presents Review and Discussion of Recent Key Business Bankruptcy Decisions/Cases
By Montali, Honorable Dennis, Dumas, Cecily & Oliner, Ron*
"Recent Developments in Business Bankruptcy — 2009” was the subject of a comprehensive panel presentation sponsored by the Bay Area Bankruptcy Forum for attorneys throughout the greater Bay Area on October 27 at the San Jose Fairmont Hotel.
The authors, panelists and presenters at the annual evening program – The Honorable Dennis Montali, United States Bankruptcy Judge; Cecily A. Dumas, Esq., (a partner in the firm Friedman Dumas & Springwater LLP); and Ron Mark Oliner, Esq. (a partner in the firm Duane Morris LLP) – excerpted and elaborated on facts and law from the most important bankruptcy decisions handed down in the last twelve months.
[Editors Note: Space limitations prevent the RN from reprinting the
more than 80 case summaries written and discussed by the distinguished
panel. We have selected a few that seem of greatest impact – and with
greatest potential application to receiverships — and present them in two
parts in this and in our Spring 2010 issue.]
On a fair valuation, debtors might have been solvent, but were illiquid. Debtors eventually filed an amended plan of reorganization, which did not provide for any payment to judgment creditor. Judgment creditor objected to the plan on grounds that confirmation of a plan in favor of solvent debtors was unconstitutional. Both the bankruptcy court and district court disagreed.
In a well-reasoned decision affirming the bankruptcy court, the district court determined that neither the Bankruptcy Clause, U.S. Const. Art. I § 8, cl. 4, which empowers Congress “[t]o establish ... uniform Laws on the subject of Bankruptcies throughout the United States,” nor the Bankruptcy Code requires insolvency as a condition for application of the bankruptcy law. While the full scope of “the subject of Bankruptcies” in the Bankruptcy Clause has never been defined, it is broad and relates generally to the relations between creditors and debtors either unable or unwilling to pay their creditors.
Any “person” as defined by the Bankruptcy Code with good faith intent
and in financial distress is eligible to be a debtor. Petitions filed in
bad faith—i.e., without proper rehabilitation purpose or filed to
unreasonably deter and harass creditors—can be dismissed by the court.
Here, filing just days before the enforcement of a judgment, or to avoid
posting an appeal bond, and aggressive asset valuations on schedules, did
not constitute bad faith. Moreover, debtors’ proposal and confirmation of
a plan eliminated any suspicion they were using chapter 11 for an improper
The bankruptcy court dismissed the lawsuit, finding that the trustee
did not qualify as an “employer” under the Act because he was not
operating a “business enterprise in the normal commercial sense.” Rather,
the trustee was acting as a fiduciary liquidating the debtor’s assets for
the benefit of creditors. The court left open the possibility that a
Chapter 7 trustee could be subject to a WARN Act claim if the trustee
actually operates a debtor’s business “in the normal commercial sense” for
a period of time.
The Court explained that surcharge of a debtor’s claimed exemption is
justified where the debtor’s misconduct amounts to a fraud on the court
and the debtor’s creditors. Moreover, the surcharge must be calculated to
compensate the estate for the actual damage inflicted by the misconduct.
Based upon the record, the court surcharged debtor’s entire $75,000
The sale order was appealed by a pension fund which held senior debt issued by Chrysler, and various tort claimants and others. The court first reviewed the sale in light of its holding in Comm. Of Equity Security Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063 (2d Cir. 1983), and concluded that the sale was justified under the Lionel factors, and in particular the fact that the evidence showed that Chrysler was hemorrhaging cash and losing going concern value of nearly $100 million a day. The court held that this precipitous depreciation in value, among other reasons, constituted a “good business reason” for the sale.
The court also rejected the pensioner’s arguments that their liens were
stripped in violation of §363(f) of the Bankruptcy Code, noting that the
bankruptcy court found that the agent for the pensioners had consented to
the sale. The court dismissed the tort claimants’ arguments that the sale
order improperly authorized the assets to be sold free and clear of
successor liability claims, including tort claims. But while the opinion
made it clear that the court was not limiting its Lionel holding, it
discussed at length how practical realities have changed in the past 25
years since it decided Lionel.
[Editor’s note: For readers unfamiliar with bankruptcy law, many,
many thousands of bankruptcy cases have been filed in recent years for the
sole purpose of conducting a sale of company assets under Section 363 of
the Bankruptcy Code for an amount insufficient to pay all liens on the
property, with all liens to attach to proceeds of the sale. This is the
“preferred method of monetizing the assets of the debtor company” the
opinion describes. Such sales cannot be conducted by state courts which,
unlike federal bankruptcy courts, do not have statutory authority to order
a sale for a price which will not pay all lienholders in full, to the
regret of many a receiver. Or do they? See below.]
Chapter 7 trustee moved to sell debtor’s personal property free and clear of liens. Lienholders objected to the sale, arguing that a bankruptcy court may not authorize a sale free and clear over the objection of a secured party unless the secured claim is being paid in full, citing to Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (9th Cir. BAP 2008). The court disagreed, finding that if the sale could not proceed under §363(f)(3) (authorizing a sale free and clear of a lien where “the price at which such property is to be sold is greater than the aggregate value of all liens on such property”), a sale free and clear could still proceed under 363(f)(5) (authorizing a sale free and clear where the lienholder “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest”) even if the sale proceeds were insufficient to satisfy all liens.
In particular, the court found that under Washington law there are legal and equitable proceedings in which a junior lienholder may be compelled to accept a money satisfaction of its interest, such as a senior secured party’s disposition of collateral under Washington’s version of Article 9. Also, Washington law authorizes a receiver to sell free and clear of liens “whether or not the sale will generate proceeds sufficient to fully satisfy all claims secured by the property...” RCW 7.60.260.
The court went on to identify other candidates, including liquidation
of a probate estate or a personal property tax sale, both under Washington
law, as well as a federal tax lien sale. Moreover, with respect to real
property, the court noted that judicial and nonjudicial foreclosure sales
under Washington law operate to clear junior lienholders’ interests such
that their liens attach to the sale proceeds (to the extent proceeds
remain following satisfaction of senior liens).
[Editor’s note: This Washington State statute authorizing receivers
to sell property free and clear of liens is of suspect constitutionality.
Article I of the U.S. Constitution, “The Legislative Branch,” provides in
part at Section 10 “Powers Prohibited to States” as follows: “No State
shall … pass any Bill of Attainder, ex post facto Law, or Law impairing
the Obligation of Contracts,….” A state law that strips a lien from real
property without payment in full arguably is a law that impairs the
obligation of contracts. California has no counterpart to this Washington
State statute. Should it?]
In the face of this possibility, the debtor’s management filed a petition for relief under Chapter 11, and moved the bankruptcy court to order the receiver to turn over its property. The receiver moved to dismiss the case on the grounds that the petition’s filing was precluded by the terms of his appointment order.
The bankruptcy court rejected that argument, explaining that the uniformity of federal bankruptcy relief would be jeopardized if its availability were subject to limitation by state-law receivership proceedings. The court also found that the debtor and its creditors would not be better served by dismissal (the standard under Bankruptcy Code §503(a)(1)), given the legitimate possibility that the debtor’s plan for a more relaxed sale schedule would bring in more money than the receiver’s “quick sale” arrangement.
But although the court refused to dismiss the case, it also declined to
order the receiver to turn over the debtor’s property. Under §543(d)(1),
turnover by a custodian may be excused if the creditors’ interests would
be better served by his maintaining custody or control—and in this case,
the debtor’s management had already shown itself far less capable than the
receiver. The court also denied the debtor’s cash collateral motion, even
though doing so could leave the estate unable to meet its administrative
expenses. Given that the bankruptcy filing seemed to have been primarily
for the benefit of the equity interest holders, the court had no problem
letting them bear the case’s up-front costs, pending their hoped-for plan
The bankruptcy court concluded that this was unacceptable. In a Chapter 11 case, prepetition creditors are generally only paid pursuant to a confirmed plan. The debtors tried to get around that restriction by arguing that their payment to GE was in the “ordinary course” of business, and that it was being made to a “critical vendor” and so was within the “doctrine of necessity.” But saying that a payment is made in the ordinary course of business is a defense against a prepetition payment being deemed preferential; it does not justify postpetition payment of a prepetition debt.
And although courts may occasionally authorize early payment to
critical vendors, there must be strong evidence that the payment is
critical to the debtor’s reorganization. Here, the court was unconvinced
that the success of reorganization depended on routing more than 80% of
the initial DIP-financing back the financier.
*The Hon. Dennis Montali is a United States Bankruptcy Judge
sitting in the San Francisco Division of the Northern District of