The Insolvency Blog

Ninth Circuit “Proceeds” to Clarify the Definition of “Goods”: The Proceeds of Goods are Goods

            In a soon to be published opinion, IPC (USA), Inc. v. Ellis (In re Pettit Oil, Co),[1] the Court of Appeals for the Ninth Circuit determined that the definition of “goods” as used in U.C.C. § 9-319(a) includes “proceeds– i.e., money and accounts receivable generated from the sale of goods. 

            Under bankruptcy law, if a consignee files for bankruptcy, any consigned “goods” in its possession become property of the bankruptcy estate unless the consignor has previously provided public notice of, and perfected its interest in, the goods.  In In re Pettitt Oil Co., the Court of Appeals considered whether U.C.C. § 9-319(a), which grants a consignee “rights and title to the goods,” also grants the consignee an interest in the proceeds of those goods that were generated prior to a bankruptcy filing.  In holding that the liquidation trustee for Pettit Oil Company (the “Debtor”) was entitled to retain approximately $5.5 million in cash and accounts receivable that the Debtor owed to a fuel supplier when the Debtor filed for bankruptcy, the Court of Appeals essentially clarified that the rules governing secured transactions, as laid out in Article 9 of the U.C.C., also govern “consignment transactions.” 

            Prior to filing bankruptcy, the Debtor, a distributor of bulk petroleum products, entered into a consignment agreement with IPC (USA), Inc. (“IPC”), whereby the Debtor stored and distributed IPC oil products.  When the Debtor filed bankruptcy, it possessed fuel and proceeds from the sale of IPC’s fuel in the form of cash and accounts receivable.  After the Debtor filed for bankruptcy, the liquidation trustee (the “Trustee”) commenced an adversary proceeding seeking the value of the fuel in the Debtor’s possession at the time of the bankruptcy filing, as well as the value of the accounts receivable and cash proceeds related to the oil products, for the benefit of the bankruptcy estate. 

            The Trustee’s adversary proceeding centered on a primary tenant of bankruptcy law, section 544(a)(1) of the Bankruptcy Code, which provides that when a debtor files bankruptcy, the bankruptcy trustee is granted a judicial lien over all property the debtor owns as of the petition date.  The Trustee claimed that IPC’s interest in the fuel and proceeds was subordinate to the estate’s interest because (1) the estate had an ownership interest in the property, pursuant to U.C.C. § 9-319(a), which provides “for purposes of determining the rights of creditors of . . . a consignee, while the goods are in the possession of the consignee, the consignee is deemed to have rights and title to the goods identical to those the consignor had”; (2) a creditor wishing to shield assets from the reach of the Trustee may only do so by demonstrating that it has priority superior to the judicial lien arising under section 544 of the Bankruptcy Code; (3) IPC never filed a financing statement or perfected its interest in the consigned “goods”; and (4) therefore, the Trustee’s judicial lien was superior to any interest held by IPC.  The bankruptcy court granted summary judgment in the Trustee’s favor, and a Bankruptcy Appellate Panel affirmed.  IPC appealed.

            On appeal, IPC argued, among other things, that because the drafters of U.C.C. § 9-319 used the term “goods” as opposed to “goods and proceeds,” Article 9 cannot dictate the treatment of proceeds of consigned goods, and, accordingly, the Trustee had no right to retain the cash and receivables generated from the sale of IPC’s fuel.  In other words, IPC asserted that U.C.C. § 9-319 did not apply to proceeds because proceeds were not “goods.” 

            The Court of Appeals disagreed, however, calling IPC’s interpretation of 9-319 “strained.”  The Court determined that “under [U.C.C. § 9-319] even though the consignee doesn’t actually own the goods, he is treated as having an ownership interest” and “the most natural reading” of Article 9 is that “a consignor’s interest in goods (and the related proceeds) is a security interest for all purposes—including for purposes of perfection and priority—unless the U.C.C. specifically says otherwise.” 

            As a result, the Court of Appeals unequivocally held that the term “goods” in U.C.C. § 9-319 includes the proceeds from such goods, and that the priority and perfection rules relating to consignments apply equally to goods and proceeds.  The Court opined that its interpretation is consistent with the rationale behind the U.C.C. and protects the delicate balance that the U.C.C. drafters struck between the interests of a consignor and a consignee’s creditors. To the outside world, goods in possession of a consignee are property of the consignee, and creditors might reasonably believe as much when they decide to lend the consignee money.  A consignor having a perfected security interest in the goods puts potential creditors on notice about the true ownership of the goods, and absent such notice, unwary creditors are protected from lending money based upon property with encumbered by “secret liens.”  Accordingly, the Court of Appeals’ decision has further confirmed that a consignor must be especially wary when conducting business with a consignee in a distressed industry or environment.

 

[1] IPC (USA), Inc. v. Ellis (In re Pettit Oil, Co), No. 17-60081, 2019 WL 1104662 (9th Cir. 2019) [ECF No. 41].

The Fifth Circuit Rules that Louisiana Statutory Mineral Liens Are Extinguished as to Production Payments Sold in Arms Length Transactions, Without Notice

            Most oil and gas producing states have oil and gas mineral lien statutes (similar to what many lawyers know as mechanics and materialman’s lien statutes) that grant automatically arising liens in favor of vendors that provide services in connection with oil and gas well operations.  Louisiana’s version of the statute is known as the Louisiana Oil Well Lien Act (or “LOWLA”).¹   On June 14, 2018, in a case of first impression, the United States Court of Appeals for the Fifth Circuit entered a final judgment affirming for purposes of LOWLA’s “safe harbor” provision that the sale of a production payment qualifies as the sale or transfer of “hydrocarbons” (under the terms of the statute).  Accordingly, the Court held that LOWLA’s safe harbor operates to extinguish statutory liens as to production payments that are conveyed in “bona fide onerous transactions.”  The Fifth Circuit panel’s opinion was issued on April 17, 2018,² and was subject to a motion for rehearing en banc until June 14, 2018.  Thompson & Knight represented the owner of the production payment, OHA Investment Corporation, before the bankruptcy court, district court and the Fifth Circuit Court of Appeals.³ 

            Notably, the Fifth Circuit’s decision is the only case in American jurisprudence that has considered whether a vendor’s statutory lien can attach to (and follow) a subsequently conveyed non-cost bearing interest in an oil and gas lease.  The case is significant and may provide guidance to other courts to the extent similar claims are asserted under mineral lien statutes of other oil and gas producing states. 

            In OHA Inv. Corp. v. Schlumberger Tech. Corp. (In re ATP Oil & Gas Corp.),  OHA had purchased a production payment a/k/a a term overriding royalty interest (the “Term ORRI”) in outer continental shelf oil and gas properties owned and operated by ATP, an oil and gas exploration and production company.  When ATP filed bankruptcy and failed to pay its vendors, many of those vendors sued OHA in bankruptcy court claiming that their automatically arising liens against ATP’s oil and gas lease incepted prior to OHA’s purchase of its Term ORRI; therefore, they claimed that their liens attached to ATP’s property and followed the conveyance of the Term ORRI from ATP to OHA.  The lien claimants were asserting rights to disgorge over $35 million in royalties paid to OHA.   OHA moved to dismiss the claims arguing, among other things, that LOWLA’s safe harbor provision applied to its purchase of the Term ORRI and LOWLA extinguished any liens that would have attached. 

            OHA’s motion to dismiss was granted by the United States Bankruptcy Court for the Southern District of Texas, affirmed (on recommendation) by the District Court and unanimously affirmed by the Fifth Circuit panel.

For more information on the Thompson & Knight Bankruptcy and Restructuring Practice, please click here.

 

[1]  See La. R.S. § 9:4861, et. seq.

[2]  OHA Inv. Corp. v. Schlumberger Tech. Corp. (In re ATP Oil & Gas Corp.), 888 F.3d 122 (5th Cir. 2018).

[3]  The legal team principally included Tye C. Hancock (argued), Mitchell E. Ayer and Richard B. Phillips.  

8th Circuit Prohibits Substantive Consolidation of Archdiocese with Non-Profit Non-Debtors

            Bankruptcy courts rely on Bankruptcy Code section 105(a) to grant the relief of substantive consolidation, which expands a debtor’s bankruptcy estate to include additional entities or assets under appropriate circumstances. The boundaries of this equitable power were tested in connection with not-for-profit entities in a recent Eighth Circuit ruling, In re Archdiocese of Saint Paul and Minneapolis,[1] whereby the court declined to extend the remedial power to non-profit, non-debtor entities.   

            On January 16, 2015, the Archdiocese of Saint Paul and Minneapolis (“Debtor”) filed chapter 11 bankruptcy in the United States Bankruptcy Court for the District of Minnesota likely to halt hundreds of claims of clergy sexual abuse. In May 2016, the Official Committee of Unsecured Creditors (the “Creditors’ Committee”), representing more than 400 clergy sexual abuse claimants, filed a motion to substantively consolidate the Debtor with over 200 affiliated non-profit, non-debtor entities (collectively, the “Targeted Entities”[2]).

            In their motion for substantive consolidation, the Creditors’ Committee alleged that the test for substantive consolidation had been met because the Debtor had direct control and supervision in all material aspects of the Targeted Entities. The bankruptcy court denied the motion and on appeal, the district court affirmed.

            On appeal, the Eighth Circuit determined that the bankruptcy court lacked authority to substantively consolidate the Targeted Entities with the Debtor as a result of the general rule that “a bankruptcy court may not contravene specific statutory provisions” of the Bankruptcy Code.[3] The contravening statutory provision was Bankruptcy Code section 303(a), which expressly excepts “a corporation that is not a moneyed, business, or commercial corporation” from involuntary chapter 7 or 11 bankruptcy. Because the Targeted Entities were considered “not a moneyed, business, or commercial corporation,” the court found that allowing for substantive consolidation of these “truly independent” non-profit entities with the Debtor would impermissibly force the Targeted Entities into involuntary bankruptcy.  

            Notably, the court left unresolved whether a non-profit, non-debtor entity that is the alter ego of the debtor can be substantively consolidated with the debtor’s estate. This decision is one of first impression on the issue of bankruptcy courts substantively consolidating a debtor’s estate with a non-profit, non-debtor entity.

For further information, please contact a Thompson & Knight Bankruptcy and Restructuring Attorney.

For more information on the Thompson & Knight Bankruptcy and Restructuring Practice, please click here.

 

[1] 888 F.3d 944 (8th Cir. 2018).

[2] The Targeted Entities were made up of “over 200 affiliated non-profit non-debtors.”  Specifically, the Targeted Entities were 187 parish corporations, several primary and secondary schools, the Catholic Community Foundation of Minnesota, the Francophone African and Gichitwaa Kateri Chaplaincies, Segrado Corizon de Jesus, the Newman Center and Chapel, the Catholic Cemeteries, and the Catholic Finance Corporation.

[3] See Law v. Siegel, 571 U.S. 415 (2014) (holding that a bankruptcy court has “necessary or appropriate” authority to carry out provisions of the Bankruptcy Code, however, in exercising this authority, a bankruptcy court may not contravene specific statutory provisions of the Bankruptcy Code).

EXCO Resources, Inc. Files Ch. 11 Bankruptcy

    On January 15, 2018, EXCO Resources, Inc. (the “Debtor”) and certain of its affiliated entities[1] (collectively, the “Debtors”) filed chapter 11 bankruptcy in the United States Bankruptcy Court for the Southern District of Texas.  According to the Debtors’, they are engaged in the exploitation, exploration, acquisition, development and production of onshore U.S. oil and natural gas properties, focusing on shale resource plays in Texas, Louisiana, and the Appalachia region. 

    The Debtor estimates its number of creditors to be between 10,000 and 25,000, and estimates that its assets are worth approximately $830 million.  The Debtor states that its liabilities are approximately $1.3 billion, and that it anticipates that funds will be available for distribution to unsecured creditors. 

    The list of creditors holding the 50 largest unsecured claims is comprised of predominately trade debts in connection with the production and supply of oil and gas totaling approximately $282 million.

    The Debtor lists five entities as owning five percent or more of the Debtor’s common stock.  These five entities are: Energy Strategic Advisory Services LLC; Fairfax Financial Holdings Limited; WL Ross & Co. LLC; and OCM EXCO Holdings LLC, OCM Principal Opportunities Fund IV Delaware LP.

For further information, please contact a Thompson & Knight Bankruptcy and Restructuring Attorney.

For more information on the Thompson & Knight Bankruptcy and Restructuring practice, please click here.

 

[1] EXCO GP Partners Old, LP; EXCO Holding (PA), Inc.; EXCO Holding MLP, Inc.; EXCO Land Company, LLC; EXCO Midcontinent MLP, LLC; EXCO Operating Company, LP; EXCO Partners, GP, LLC; EXCO Partners OLP GP, LLC; EXCO Production Company (PA), LLC; EXCO Production Company (WV), LLC; EXCO Resources (XA), LLC; EXCO Services, Inc.; Raider Marketing GP, LLC; Raider Marketing, LP.

Expro Holdings Files Ch. 11 Bankruptcy in Texas

    On December 18, 2017, Expro Holdings US Inc. (d/b/a Umbrellastream US Inc.) (the “Debtor”) and certain of its affiliated entities[1] (collectively, the “Debtors”) filed chapter 11 bankruptcy in the United States Bankruptcy Court for the Southern District of Texas.  The Debtors provide specialized well flow management products and services in the oil and gas industry, specifically focusing on offshore, deepwater and other environments.  The Debtors cite a significant and sustained drop in oil and gas prices as the catalyst for filing chapter 11 bankruptcy.

    According to the Declaration of John McAlister, the Group General Counsel and Corporate Secretary of Expro International Group Holdings Limited (the indirect parent company for each of the Debtors), the Debtors’ bankruptcy seeks to implement a consensual financial restructuring that has the support of supermajorities of both the Debtors’ secured creditors and equity holders.  HSBC Bank USA, National Association, serves as administrative agent and HSBC Corporate Trustee Company (UK) Limited serves as collateral agent for the senior secured lenders.  The Bank of New York Mellon (London Branch) serves as facility agent and HSBC Corporate Trustee Company (UK) Limited serves as the security agent for the mezzanine lenders.  Under the restructuring support agreement, (i) senior lenders will receive their pro rata share of 100% of the equity in the reorganized Debtors, (ii) the mezzanine lenders have the opportunity to receive their pro rata share of new warrants to be issued, (iii) trade and other unsecured claims will be paid in full in the ordinary course of business,[2] (iv) existing shareholders have the opportunity to receive their pro rata share of new warrants, and (v) the reorganized Debtors will raise $200 million in new capital through a backstopped rights offering open to senior lenders who have already joined or executed the restructuring support agreement.  

    Concurrently with their bankruptcy petitions, the Debtors filed their Disclosure Statement and Chapter 11 Plan of Reorganization.  

A copy of the Declaration of John McAlister can be found by clicking here:  Download Expro Holdings - 1st Day Declaration

For further information, please contact a Thompson & Knight Bankruptcy and Restructuring Attorney.

For more information on the Thompson & Knight Bankruptcy and Restructuring practice, please click here.

 

[1] Expro Group Australia Pty Limited; Expro Holdings Australia 1 Pty Limited; Expro Holdings Australia 2 Pty Limited; Expro Do Brasil Servicos Ltda; Expro (B) Sendirian Berhad; Expro Group Canada Inc.; Expro Gulf Limited; Exploration and Production Services (Holdings) Limited; Expro Benelux Limited; Expro Eurasia Limited; Expro Holdings UK 2 Limited; Expro Holdings UK 3 Limited; Expro Holdings UK 4 Limited; Expro International Group Holdings Ltd.; Expro International Group Limited; Expro North Sea Limited; Expro Overseas Limited; Expro Resources Limited; PT Expro Indonesia; Expro International Limited; Expro Finservices Sarl; Expro Servicios S. de R.L. de C.V.; Expro Tool S. de R.L. de C.V.; Exprotech Nigeria Limited; Expro Holdings Norway AS; Expro Norway AS; Petrotech AS; Expro Overseas, Inc.; Expro International B.V.; Expro Worldwide B.V.; Petrotech B.V.; Expro Trinidad Limited; Expro Americas, LLC; Expro Holdings US Inc.; Expro Meters, Inc.; Expro US Finco LLC; Expro US Holdings, LLC.

[2] The Debtors estimate the total outstanding pre-petition trade claims to be $102 million.

Cobalt International Energy Files Chapter 11 Bankruptcy in Texas

On December 14, 2017, Cobalt International Energy, Inc. (the “Debtor”) and certain of its affiliates[1] (collectively, the “Debtors”) filed chapter 11 bankruptcy in the United States Bankruptcy Court for the Southern District of Texas.

According to the Declaration of David D. Powell, the Debtor’s Chief Financial Officer, the Debtors are independent exploration and production companies operating in the deepwater U.S. Gulf of Mexico and offshore Angola and Gabon in West Africa regions.  The Debtors cite a failed prepetition sale of its Angola assets and the low commodity prices and general market uncertainty as catalysts for filing bankruptcy.

According to the Debtor’s bankruptcy petition, it anticipates that funds will be available for distribution to unsecured creditors.  The Debtor lists the number of creditors as between 100-200.  Per the Declaration of David. D. Powell, the Debtors have approximately $2.8 billion in total funded debt.  Further, the Debtor’s list of creditors holding the 30 largest unsecured claims is comprised almost exclusively of trade debts.

The Debtors intend to offer for sale all of their assets, either individually or as an entire going concern, and state that they are in discussions with potential buyers.  To that end, the Debtors are seeking court approval of bidding procedures in connection with an anticipated auction.  The Debtors also seek authority to pay all prepetition and post-petition amounts owing on account of working interest expenditures, joint interest billings, royalties, delay rental payments and production sale expenditures.

The case is styled In re Cobalt International Energy, Inc., et al. and is case number 17-36709 pending in the United States Bankruptcy Court for the Southern District of Texas.

A copy of the Declaration of David D. Powell can be found by clicking here:  Download Cobalt Intl Energy - 1st Day Declaration (2). 

For further information, please contact a Thompson & Knight Bankruptcy and Restructuring Attorney.

For more information on the Thompson & Knight Bankruptcy and Restructuring practice, please click here.

 

[1] Cobalt International Energy GP, LLC; Cobalt International Energy, L.P.; Cobalt GOM LLC; Cobalt GOM #1 LLC; and Cobalt GOM #2 LLC.

Pacific Drilling Files Ch. 11 Bankruptcy in New York

            On November 12, 2017, Pacific Drilling S.A. (the “Debtor”), a Luxembourg public limited liability company, and certain of its affiliates[1] (collectively, the “Debtors”) filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the Southern District of New York.

    According to the Declaration of Paul T. Reese, the Debtor’s Chief Executive Officer, the Debtors are engaged in international offshore drilling, specializing in ultra-deepwater and complex well construction services.  The Debtors cite a decrease in the oil and gas prices and a decrease in offshore deepwater drilling projects as the catalyst for the Debtors filing Chapter 11 bankruptcy.

    Based on the Debtor’s bankruptcy petition, it estimates that funds will be available for distribution to unsecured creditors, and estimates that it has between 1,000 and 5,000 creditors.  The Debtor also estimates that it has assets worth between $1 billion and $10 billion, seeming to consist primarily of vessels or drillships.  Further, the Debtor’s Consolidated List of Creditors who hold the 30 largest unsecured claims is comprised of trade debts appearing to be related to offshore drilling services.

    The Debtors have sought authority to pay the pre-petition claims of certain critical vendors, namely those entities that provide specialized equipment, parts, transportation of personnel and supplies, shipping, warehousing, communications, medical services, maintenance and repairs, janitorial services, financial and legal services, human resources, certifications and safety inspections.  The Debtors estimate that the aggregate pre-petition claims of these critical vendors is no more than $4.5 million.  Similarly, the Debtors have also requested authority to pay the pre-petition claims of certain foreign trade vendors, which claims are estimated to be approximately $1.7 million in the aggregate.

    The case is styled In re Pacific Drilling S.A., et al., and is case number 17-13193 pending in the United States District Court for the Southern District of New York.

A copy of the Declaration of Paul T. Reese can be found by clicking here:  Download Pacific Drilling - Paul T. Reese Declaration

For further information, please contact a Thompson & Knight Bankruptcy and Restructuring Attorney.

For more information on the Thompson & Knight Bankruptcy and Restructuring Practice, please click here.

 

[1] Pacific Drilling S.A., Pacific Drilling (Gibraltar) Limited, Pacific Drillship (Gibraltar) Limited, Pacific Drilling, Inc., Pacific Drilling Finance S.à r.l., Pacific Drillship SARL, Pacific Drilling Limited, Pacific Sharav S.à r.l., Pacific Drilling VII Limited, Pacific Drilling V Limited, Pacific Drilling VIII Limited, Pacific Scirocco Ltd., Pacific Bora Ltd., Pacific Mistral Ltd., Pacific Santa Ana (Gibraltar) Limited, Pacific Drilling Operations Limited, Pacific Drilling Operations, Inc., Pacific Santa Ana S.à r.l., Pacific Drilling, LLC, Pacific Drilling Services, Inc., Pacific Drillship Nigeria Limited, and Pacific Sharav Korlátolt Felelősségű Társaság.

ExGen Texas Power, LLC Files Ch. 11 Bankruptcy in Delaware

            On November 7, 2017, ExGen Texas Power, LLC (the “Debtor”), a Delaware corporation, and certain of its affiliates[1] (collectively, the “Debtors”) filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the District of Delaware. 

    According to the Declaration of David Rush, the Debtor’s Chief Restructuring Officer, the Debtors provide natural gas-fired power generation throughout Texas and provide electric power to approximately 24 million Texas customers.  As the catalyst for their bankruptcy filings, the Debtors cite the downturn in the energy sector and resulting decrease in energy market prices as causing them to realize an unsupportable decrease in profit. 

    Leading up to the bankruptcy filing, certain of the Debtors entered into a stalking-horse purchase agreement with a non-debtor, Exelon Generation Company, LLC (“ExGen”), whereby ExGen will acquire Debtor-Hadley Power, LLC for $60 million, subject to higher and better offers and approval of the Debtors’ plan of reorganization.  This stalking-horse purchase agreement appears to have the support of the Debtors and secured lenders. 

    Based on the Debtor’s bankruptcy petition, it anticipates that funds will be available for distribution to unsecured creditors.  The Debtor estimates that the number of creditors is between 200 and 999, and lists its liabilities as between $500 million and $1 billion.  Further, the Debtor’s Consolidated List of Creditors who hold the 30 largest unsecured claims is comprised of exclusively trade debts appearing to be related to energy-related activities.

    The Debtors have sought authority to pay pre-petition claims of certain critical vendors totaling approximately $6 million, as well as to pay outstanding pre-petition purchase orders for goods and services that have not yet been delivered but are integral to the Debtors’ businesses.

The case is styled In re ExGen Texas Power, LLC, et al. and is case number 17-12377 pending in the United States Bankruptcy Court for the District of Delaware.

A copy of the Declaration of David Rush can be accessed by clicking here.

For further information, please contact a Thompson & Knight Bankruptcy and Restructuring Attorney.

For more information on the Thompson & Knight Bankruptcy and Restructuring Practice, please click here.

 

[1] ExGen Texas Power Holdings, LLC; Wolf Hollow I Power, LLC; Colorado Bend I Power, LLC; Handley Power, LLC; Mountain Creek Power, LLC; LaPorte Power, LLC.

Lower Courts Interpret U.S. Supreme Court's Jevic Decision

            In Czyzewski v. Jevic Holding Corp., the United States Supreme Court made clear that bankruptcy courts cannot approve structured dismissals that provide for distributions in violation of the Bankruptcy Code’s priority scheme without the consent of the affected parties.[1]  For an in-depth analysis of the Jevic decision, please read our previous blog post by clicking here. 

            It has not taken long for Jevic to begin affecting settlement agreements in bankruptcy courts across the country.  For example, hardly a month after the Jevic decision, a bankruptcy court in the Eastern District of Tennessee struck down a proposed settlement agreement because the settlement agreement proposed a distribution whereby one creditor would be preferred in violation of the priority scheme set forth in Section 507 of the Bankruptcy Code.[2]  In In re Fryar,[3] the proposed settlement called for a bank to receive a distribution in full satisfaction of its $350,000 lien on real property worth only $200,000.  Thus, under the proposed settlement, the bank would receive a $150,000 distribution on its unsecured claim before other creditors with higher statutory priority received distributions, such as the Internal Revenue Service (“IRS”) which had a pre-existing tax lien on the debtor’s property.  Further, the bank would be paid in full for its general unsecured claim, while the other general unsecured creditors would have received a pro-rata share of the amount remaining in the bankruptcy estate once all other higher priority claims were paid.

            The court found that the proposed $350,000 distribution to the bank violated the Bankruptcy Code’s priority scheme.  In so holding, the court found that the proper distribution of the $350,000 under the Bankruptcy Code should go first to satisfy the IRS’ lien, and the remaining proceeds would then be distributed to priority unsecured creditors before finally being distributed to general unsecured creditors on a pro-rata basis.  While the court noted that under Jevic, if all of the affected creditors (i.e., the priority and general unsecured creditors who would otherwise be statutorily entitled to an earlier distribution absent the proposed settlement) consented to the proposed settlement, the court may have approved the settlement; but since three creditors who were entitled to a higher priority under the bankruptcy code objected, the court had no choice but to deny the settlement as it was currently structured.

            In In re Constellation Enterprises LLC,[4] a bankruptcy court denied a settlement agreement because it did not comply with the strictures of Jevic and the Bankruptcy Code’s priority scheme.  The proposed settlement agreement would have created a general unsecured creditor litigation trust (the “Litigation Trust”) with lawsuit rights assigned to it by a company formed by the debtor’s secured noteholders.  Additionally, the agreement also would have given the Litigation Trust $2.05 million for payment of the creditor committee’s professionals’ fees.

        The two creditors, along with the U.S. Trustee and the IRS, objected to the proposed settlement agreement.  The objecting parties claimed that this proposed settlement—which would create the Litigation Trust—bypassed creditors with higher priority under the Bankruptcy Code, thereby leaving these higher priority creditors to receive little or no distributions.[5]

        In denying the proposed settlement, the bankruptcy judge orally ruled that while he “den[ied]the settlement motion” with “some reluctance,” he was “constrained to do so by the facts [of the case] and by the law.”  Notably, the judge also stated that he believed the debtor’s bankruptcy was “headed to . . . dismissal or conversion [to chapter 7]” and not to a successful reorganization under chapter 11. 

        Thus, the decision in Fryar and Constellation illustrate that after Jevic, bankruptcy courts appear to require settlement agreements to either (i) comply with the Bankruptcy Code’s priority scheme or (ii) require that all negatively affected creditors consent to a distribution that contravenes the Bankruptcy Code’s priority scheme.

 

[1] Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017).

[2] 11 U.S.C. § 507 (West).

[3]  1:16-BK-13559-SDR, 2017 WL 1489822 (Bankr. E.D. Tenn. Apr. 25, 2017).

[4] Constellation Enterprises LLC, Case No. 1:16-bk-11213 (Bankr. D. Del. May 16, 2016).

[5] 11 U.S.C. § 507.

U.S. Supreme Court Approves Structured Dismissals in Certain Circumstances

            On March 22, 2017, the United States Supreme Court issued its ruling in Czyzewski v. Jevic Holding Corp.,[1] holding 6-2 that bankruptcy courts cannot approve structured dismissals that provide for distributions in violation of the Bankruptcy Code’s priority scheme without the consent of the affected parties.

            The Court’s holding is an appeal from a decision by the Third Circuit Court of Appeals which held that bankruptcy courts could, in “rare cases,” approve structured dismissals that provide distributions in violation of the Bankruptcy Code’s priority scheme. For a discussion of the underlying facts of the case and of the Third Circuit’s holding, please read our previous post by clicking here. 

            In reaching its decision, the Court noted that while the Bankruptcy Code “makes clear” that distributions made in a chapter 7 liquidation must adhere to the Bankruptcy Code’s priority scheme and that distributions in a confirmed chapter 11 plan of reorganization “may impose a different ordering with the consent of the affected parties,”[2] a bankruptcy court cannot grant a dismissal of a chapter 11 bankruptcy that provides for distributions in violation of the priority scheme, absent the consent of the affected parties.

            While the Court conceded that a bankruptcy court can dismiss a case “for cause”[3]—which typically returns the parties to the status quo ante, and the orders in the bankruptcy case do not survive—and that section 349(b) of the Bankruptcy Code permits a court “for cause, [to] order[] otherwise,” the Court found that the word “cause” “[was] too weak a reed upon which to rest so weighty a power” of a bankruptcy court to make final distributions that contravene the priority system in connection with the dismissal of a chapter 11 case (absent the affected parties’ consent).[4]

            The Court also distinguished In re Iridium Operating, LLC,[5] a Second Circuit decision relied upon by the Third Circuit in Jevic.  The Supreme Court noted that Iridium did not involve a structured dismissal, but rather “addressed an interim distribution of settlement proceeds to fund a litigation trust that would press claims on the estate’s behalf.”[6]  Therefore, Iridium did not support the Third Circuit’s decision that the Bankruptcy Code permits structured dismissals that deviate from the Bankruptcy Code’s priority scheme in “rare cases.”  The Supreme Court emphasized that the consequences of permitting structured dismissals that deviate from the Bankruptcy Code’s priority scheme “are potentially serious” and include (i) departing from the statutory priorities enacted by Congress, (ii) changes in the bargaining power between different creditor-classes, and (iii) the risk of collusion whereby “senior secured creditors and general unsecured creditors team[] up to squeeze out priority unsecured creditors.”[7]

            The Court further recognized that other bankruptcy decisions have approved interim distributions that violated the Bankruptcy Code’s priority scheme. However, the Court distinguished those cases from Iridium and Jevic because “in such instances one can generally find significant Code-related objectives that the priority-violating distributions serve,” and “make even the disfavored creditors better off.”  Examples of such interim distributions are courts approving “first-day” wage orders permitting payment of employees’ pre-petition wages, “critical vendor” orders permitting payment to vital suppliers, and “roll-ups” permitting lenders that continue to provide post-petition financing to be paid first on their pre-petition claims.[8]  

            Importantly, the Supreme Court’s decision did not disapprove of the use of structured dismissals that do not violate the Bankruptcy Code’s priority scheme.  In particular, the Court noted that “[w]e express no view about the legality of structured dismissals in general.”[9]  Thus, it appears that while a bankruptcy court cannot grant a structured dismissal that violates the Bankruptcy Code’s priority scheme absent consent of affected parties, the Court did not foreclose the permissibility of a structured dismissal that does not deviate from the priority scheme or a structured dismissal that deviates from the priority scheme but where all affected parties consent.  

 

            A copy of the Supreme Court’s opinion can be found by clicking here.

            For further information, please contact a Thompson & Knight Bankruptcy and Restructuring Attorney.

            For more information on Thompson & Knight’s Bankruptcy and Restructuring Practice, please visit http://www.tklaw.com/bankruptcy-and-restructuring/.

           

 

[1] 137 S. Ct. 973 (2017).

[2] See 11 U.S.C. §§ 1129(a)(7), 1129(b)(2).

[3] See 11 U.S.C. § 1112(b).

[4] 137 S. Ct. at 985.

[5] 478 F.3d 452 (2d Cir. 2007).

[6] 137 S. Ct. at 985 (emphasis in original).

[7] Id. at 986.

[8] Id. at 985.

[9] Id. at 986.