In Blixseth v. Brown (In re Yellowstone Mountain Club), 841 F.3d 1090 (9th Cir 2016), the Ninth Circuit extended the Supreme Court’s holding in Barton v. Barbour, 104 U.S. 126 (1881), requiring a plaintiff to first obtain the bankruptcy court’s permission before suing a court appointed officer in another court, to apply to suits against the members of a creditors’ committee. In finding that “creditors have interests that are closely aligned with those of a bankruptcy trustee, there’s good reason to treat the two the same for purposes of the Barton doctrine,” the panel concluded that Barton applies to committee members who are sued for acts performed in their official capacities. This is the first circuit level opinion extending such protection to committee members.
Just read an informative article published by Chadbourne & Parke in its International Restructuring Newswire discussing large company bankruptcy filings during 2015 and significant court decisions. Take a look. http://www.chadbourne.com/Year-In-Review-IR-Winter-2016
On January 29, 2016, the United States Bankruptcy Court for the District of Delaware refused to approve a provision in a retention application that would have allowed counsel to be reimbursed by the bankruptcy estate for fees incurred in a successful defense of an objection to their fees in the case. See In re Boomerang Tube, Inc., Case No. 15-11247 (Bankr. D. Del. Jan. 29, 2016).
In Boomerang Tube, proposed counsel to the committee of unsecured creditors filed a retention application which provided, among other things, for indemnification by the estate for expenses incurred in any successful defense of their fees. The Bankruptcy Court cited Baker Botts L.L.P. v. ASARCO LLC, 135 S. Ct. 2158 (2015), in which the United States Supreme Court affirmed a decision denying recovery of fees by a debtor’s counsel incurred in defending itself from a fee objection raised by the debtor. The Supreme Court in ASARCO relied on the language of 11 U.S.C. 330(a), which allows a court to award only “reasonable compensation for actual, necessary services rendered,” and held that a different result would violate the “American Rule” of each litigant paying its own fees.
The applicants in Boomerang Tube attempted to distinguish ASARCO by appealing to 11 U.S.C. 328, which allows compensation to professionals (if approved in advance by the court) that otherwise would not have been available under Section 330.
The Bankruptcy Court agreed that Section 328 provided an exception to Section 330. Nevertheless, the court declined to approve the indemnification provision, finding Section 328 insufficiently “specific and explicit” to create a statutory “prevailing party” exception to the American Rule.
The court further held that the terms of the proposed retention application did not amount to a contractual exception to the American Rule. Although the court agreed that counsel’s retention agreement was a contract and Section 328 does not prohibit defense fees, the court noted that there was no contractual relationship between counsel and the parties that would be responsible for paying counsel’s fees, and that the estate was not a party to the retention agreement and could not be bound.
Finally, the court held that, even if ASARCO did not preclude approval of the fee defense provisions, those provisions still could not be approved because all terms of employment must actually relate to the services to be rendered — in this case, representation of the creditors’ committee and its interests. The court held that counsel defending its own fees is not a service performed for the committee but instead for counsel itself.
Although the Bankruptcy Court’s decision is logical, practitioners must take note when calculating the risks of representing a committee — or a debtor (as the Bankruptcy Court explicitly stated its holding applies to all professional applications under 11 U.S.C. 328, and not only applications for committee counsel) — that a contractual indemnity for fees and costs incurred successfully defending objections to a fee application is not permissible, even with the client’s consent.
In a major development affecting individual chapter 11 bankruptcy debtors, the 9th Circuit Court of Appeals has overruled earlier case law and ruled that the “absolute priority rule” under 11 U.S.C. § 1129(b)(2)(B)(ii) continues to apply to individual debtors following the 2005 BAPCPA amendments to the Bankruptcy Code. See David K. Zachary v. California Bank & Trust (In re Zachary), No. 13-16402 (January 28, 2016) (“Zachary“).
After BAPCPA, it became questionable whether the absolute priority rule continued to apply in individual debtor cases. The amendments to the Bankruptcy Code included a provision (§ 1115) that added as “property of the estate,” all property of the kind specified in section 541 acquired by an individual debtor after commencement of the case in addition to property owned by the debtor as of the petition date. In conjunction therewith, BAPCPA created an exception to the absolute priority rule that allowed individual debtors to retain property “included in the estate under section 1115.” These amendments created an ambiguity that was not easily resolved, forcing the courts to consider: Could an individual debtor retain all property of the estate, including property owned at the time the Chapter 11 was filed and also property added post petition, or was the debtor limited to only property acquired post filing?
A split of authority quickly developed in the circuits over this issue. A split panel of the Bankruptcy Appellate Panel for the 9th Circuit in In re Friedman, 466 B.R. 471 (9th Cir. BAP 2012), and a majority of the district, bankruptcy appellate, and bankruptcy courts, adopted a broad view that permitted the debtor to retain all property, whenever acquired, while the Courts of Appeal for the 3rd, 4th, 5th, and 10th Circuits favored a narrower view that the debtor could only retain property acquired after the case was filed. In Zachary, the 9th Circuit has overruled In re Friedman, falling in line with its sister circuits in holding that the absolute priority rule continues to apply in individual debtor Chapter 11 cases.
On May 6, 2015, in Stahl v. Simon (In re Adamson Apparel, Inc.), 2015 US App. LEXIS 7508, the Ninth Circuit Court of Appeals became the first circuit level court to hold that an insider guarantor’s waiver of its indemnity, exoneration, contribution, and indemnity rights absolves the insider guarantor from potential preference liability for payments made to a guaranteed lender during the extended one-year preference period applicable to insiders. Such waivers (commonly referred to as “Deprizio waivers”) became a common requirement in lending transactions involving insider guaranties following the Seventh Circuit’s opinion in Levit v. Ingersoll Rand Fin. Corp. (In re Deprizio), 874 F.2d 1186 (7th Cir. 1989). That decision held that lenders holding an insider guaranty were susceptible to the extended one-year reach back period because payments made to the lender benefitted the insider guarantor creditor and were thus avoidable under 11 USC §547(b)(4)(B). Congress amended the Bankruptcy Code in 1994 to make such payments recoverable only from the insider guarantor and not the lender, making Deprizio waivers no longer necessary to protect the lender. 11 USC §§ 547(I) and 550(c). The guarantor, however, remained liable under §§ 547(b) and 550(a)(1) for those payments because it benefitted from having its guaranty liability reduced. Following the Deprizio decision, but prior to the Bankruptcy Code amendments, a number of bankruptcy courts, including the District of Oregon in Hostmann v. First Interstate Bank of Or., N.A. (In re XTI Xonix Techs, Inc.) 156 B.R. 821 (Bankr. D. Or. 1993), held that Deprizio waivers could be used to effectively shield both the lender and the guarantor from liability for the payments made to the lender within the extended one-year reach back period because the guarantor was no longer a creditor as a result of the waiver. Following the amendments, however, a number of courts began to question the validity of such waivers on public policy grounds, finding that such waivers were a sham by giving the guarantor the ability to purchase the remaining debt from the lender after the preferential payments had been made, rather than performing under the guaranty, and thereby obtaining the lender’s rights to pursue the debtor for the remaining balance owed. See In re USA Detergents, Inc., 418 B.R. 533 (Bankr. D. Del. 2009; In re Pro Page Partners, LLC, 292 B.R. 622 (Bankr. E.D. Tenn. 2003); In re Telesphere Commc’ns, Inc., 229 B.R. 173 (Bankr. N.D. Ill. 1999). Noting the validity of such concerns in Adamson, the Ninth Circuit nevertheless held that such concerns were insufficient to establish “a bright-line rule based on a fear of what could happen.” Instead, it held that courts should consider the totality of the facts for evidence of a “sham” transaction rather than just invalidate the waivers. In holding the waivers valid in Adamson, the Ninth Circuit found the following factors relevant: (1) the lender’s claim was secured and would have been satisfied to the extent of its collateral even without the guaranty, (2) the guarantor never filed a proof of claim even though it paid off the $3.5 million that remained owing to the lender, (3) the guarantor did not have a unilateral right to purchase the lender’s debt if the borrower defaulted, and (4) the trustee presented no evidence that the lender’s debt was the only debt of the company that the insider had guaranteed, reasoning that satisfying the lender’s debt first would have provided the guarantor with no benefit because it would still have been liable for the other guaranteed debts for which it had not waived its right to recover from the debtor. Although a Deprizio waiver may not be prudent in all situations, it should still be considered when insider guaranties are part of a loan transaction.
Last week, the Third Circuit Court of Appeals upheld a $2.3 million jury verdict in favor of a Creditors’ Committee, finding that the directors of a failed Pittsburgh nursing home had breached their fiduciary duties to the corporation’s creditors by failing to remove the home’s administrator and chief financial officer when their mismanagement became apparent. Official Committee of Unsecured Creditors v. Arthur Baldwin, et al. (In re Lemington Home for the Aged), 2015 U.S. App. LEXIS 1183. The court relied on the Pennsylvania corporation statutes which provide that a director shall “perform his duties as a director . . . in good faith, in a manner he reasonably believes to be in the best interests of the corporation and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances.” The court further found that the directors were liable for the tort of “deepening insolvency” in allowing the corporation to continue operating at a loss for over three months before filing bankruptcy, despite having made the decision to close the home and deplete the patient census.
Oregon and Washington corporation statutes contain language similar to the Pennsylvania statute. Although the Oregon and Washington courts have yet to formally recognize an independent tort for “deepening insolvency”, the Ninth Circuit Court of Appeals has held, without deciding whether “deepening insolvency” is a separate tort, that corporate officers/directors who prolong an insolvent firm’s existence with spurious debts, rather than dissolve it in a timely manner, can be liable to the corporation for the resulting harm. Smith v. Arthur Andersen LLP, et al. (In re Boston Chicken), 421 F.3d 989 (9th Cir. 2005). These decisions highlight the scrutiny that may be placed on board decisions made while a corporation is insolvent, and the risks officers and directors face if they allow the business to continue operating and incurring debts that might not be paid.
Effective December 1, 2014, Federal Rule of Bankruptcy Procedure 7004(e) was amended to require service of a summons in an adversary proceeding within seven days of its issuance. This cuts in half the previously allowed 14-day time period. Defendants still have 30 days from issuance of the summons to respond to the complaint.
Prior to the change, defendants often had less than two weeks to respond to a complaint that was served by first-class mail. This rule change should give defendants an extra week to respond, depending on the mail.