The practice of granting third party releases in bankruptcy was recently dealt another blow by the District Court for the Eastern District of Virginia. In Patterson et. al. v. Mahwah Bergen Retail Group, Inc., Civil No. 3:21cv167 (DJN), the District Court found that the lower bankruptcy court lacked the constitutional authority to both rule on certain of the claims covered by the third-party releases at issue and, it follows, to confirm the debtors’ plan of reorganization. The District Court went so far as to sever the third-party releases from the plan, vacating the plan and remanding the matter for consideration of the plan without the releases. But the District Court didn’t stop there. The District Court further ordered that the case be reassigned to a different bankruptcy judge in a different regional division (that is not known for consistently granting third-party releases), adding that the Chief Judge could “assign it to himself if he believes the interests of justice so warrant.” Doc. 79 at 86.
The Bankruptcy Court for the District of Delaware recently expressed its view regarding the reach of the “solvent debtor exception” in In re The Hertz Corp., et al. The solvent debtor exception is an equitable doctrine which supports the proposition that creditors are entitled to the full suite of their contractual rights if the debtor in bankruptcy is solvent. Notably, the doctrine has been advanced to support the argument that solvent debtors are required to pay post-petition interest owed to unsecured creditors at the contract rate of interest, including in some instances, the default rate.
Article 9 of the Uniform Commercial Code, adopted in all fifty states plus the District of Columbia with relatively few variations, sets out, among other things, the rules to be followed when obtaining a security interest in personal property collateral to secure a loan. The basic premise of Article 9 is that if the lender follows the rules, it should be protected against third parties, including other creditors or a bankruptcy trustee, who would seek to challenge the lender’s security interest or the priority of the security interest.
In its much-discussed decision, City of Chicago v. Fulton, 141 S. Ct. 585 (2020), the Supreme Court ruled that the City of Chicago (“City”) was not in violation of Section 362(a)(3) of the Bankruptcy Code for failing to release an impounded car to a debtor in bankruptcy. Section 362(a)(3) imposes an automatic stay over “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” According to the Supreme Court, a violation of this section requires some affirmative act beyond mere retention of a debtor’s property. Secured creditors applauded the decision as it shed some light on factors to consider when deciding whether to return property of their bankrupt borrowers that may have been impounded, seized or otherwise have come into their possession prior to bankruptcy. The Supreme Court, however, limited its ruling to the particular section before it (Section 362(a)(3)), and did not address potential automatic stay violations set forth in other sections, including Sections 362(a)(4), (6) and (7), of the Bankruptcy Code. Whether the reasoning in Fulton applies to these other sections remains an open question, but one that may soon be answered.
Periodically courts remind corporate directors that their decisions to act or to refrain from acting during the course of managing the affairs of a corporation are not without limitations. It is well established that corporate directors owe fiduciary duties, and more specifically, a duty of care and a duty of loyalty to corporate shareholders. Those duties should always be at the front of mind of every director when any action or inaction is contemplated, but in particular, when addressing challenging issues facing the corporation. Directors are afforded wide latitude under state corporate law, and by the courts interpreting those laws, to make decisions regarding the management of a corporation that are appropriately within the scope of the directors’ business judgement. But courts, and in particular bankruptcy courts with an interest in protecting a number of different stakeholders, are not shy about reminding corporate directors that the scope of protection provided by the business judgment rule is not unlimited. Such is the case with In re Sportco Holdings, Inc., et al., 2021 WL 4823513 (Bankr. D. Del.), a recent decision by the Bankruptcy Court for the District of Delaware.
With the confirmation of Carlson Travel’s plan of reorganization within 24 hours from the company’s filing, expedited confirmations took another step toward normalization. Carlson Travel (better known as Carlson Wagonlit Travel) together with 37 affiliated entities filed bankruptcy in the Southern District of Texas (Houston Division) on the evening of Thursday, November 11, 2021. The debtors managed to schedule a joint hearing on the approval of their disclosure statement and confirmation of their prepackaged plan for Friday morning, the next day. As with all pre-packs, the debtors had solicited votes on their plan prior to filing their cases, including a pre-petition notice period for objections. The company reported that it had received acceptances from all of its bank lenders and more than 90% of its other secured debt. Earlier in 2021, Belk Inc. and affiliates accomplished a similar feat in the same Court. Others to confirm their prepackaged plans on an expedited timetable include Sunguard Availability Services Capital, Inc. and FullBeauty Brands Inc., both in 2019.
Hot on the heels of crises driven by shortages of carbon dioxide and HGV drivers, it is perhaps the ultimate irony that – in the month before COP 26 in Glasgow – the UK and to a lesser extent much of the rest of the world has been rocked by a series of crises in the fossil fuel driven energy market. Whilst much of Asia is being impacted by a shortage of coal, Europe is feeling the full effects of a shortage of natural gas. This is perhaps particularly acute in the UK for a number of reasons including reduced storage capacity, issues with one of the key grid interconnectors to France, and a spike in global demand as the world economy seeks to pick up from where it left off pre-pandemic. The result? Eye watering wholesale gas prices that have risen more than double since January 2021, with a 70% increase since August. Prices rocketed a further 37% in one day on 6 October.
On the heels of this month’s confirmation of Purdue Pharma’s controversial plan of reorganization which contained third-party releases in favor of the Sackler family members, a new bill has been introduced in the Senate seeking an end to what some critics refer to as “bankruptcy forum shopping.” The bill is a companion bill to H.R. 4193, introduced in the House in June under the moniker “Bankruptcy Venue Reform Act of 2021.” The bills, if passed into law, would generally (i) require individuals to file bankruptcy in the district where their domicile, residence, or principal assets are located; (ii) require corporate debtors to file bankruptcy in the district where their principal assets or principal place of business is located (or in which there is case pending concerning an affiliate that owns, controls, or holds 50% percent or more of the outstanding voting securities of, or is the general partner of, the entity that is the subject of the later filed case); (iii) prevent corporate debtors from filing solely on the basis of their state of incorporation; (iii) prevent debtors from filing bankruptcy in a district simply because one of its affiliates has filed there; and (iv) require courts to transfer or dismiss cases filed in the wrong district. The bill would further discourage forum shopping by giving no effect to a change in the ownership or control of an entity or to a transfer of the principal place of business or principal assets of an entity that takes place within one year before the petition date or “for the purpose of establishing venue.”
While the cry for bankruptcy venue reform is not new – similar bipartisan legislation has been introduced in each of the last two sessions of Congress, and prior to that in 2011 by Senator John Cornyn (TX) – this time may be different. The recent ruling by the Bankruptcy Court for the Southern District of New York approving third-party releases for members of the Sackler family may have triggered a change in sentiment among the members of Congress (and gotten the attention of their State attorney generals and constituents). The ruling, which provides broad releases in favor of members of the family in exchange for an aggregate $4.5 billion contribution to the estate, has drawn criticism from many circles. The United States Trustee and a number of states have appealed the confirmation of Purdue Pharma’s plan of reorganization. Indeed, that change in sentiment is evidenced by the recently-introduced Nondebtor Release Prohibition Act of 2021 (S. 2497 & H.R. 4777) which would, among other things, prohibit the use of non-consensual third-party releases of the nature granted to the Sacklers (and any consent would be required in writing by creditors for consensual third party releases).
Proponents of bankruptcy reform legislation argue that Purdue Pharma engaged in forum shopping in order to bring its complex Chapter 11 case before Bankruptcy Judge Drain in White Plains, New York. They assert that the company chose White Plains because the Judge approved third party releases in the complex bankruptcy cases in the past. Currently, the Bankruptcy Code generally allows an entity to file bankruptcy in the district where (a) its domicile, principal place of business, or principal assets for 180 days immediately preceding the date of the petition (or for a longer part of such 180 days than in any other district), or (b) a bankruptcy case concerning its affiliate, general partner, or partnership is pending. Purdue Pharma LP, the parent of the Purdue corporate family, was organized in Delaware and based in Connecticut. Purdue Pharma Inc., however, was organized in New York, and once it filed its petition, all other affiliates were entitled to file there as well. Under the proposed bill, Purdue Pharma Inc., as a majority-owned subsidiary of Purdue Pharma LP, could have filed in any jurisdiction where Purdue Pharma LP satisfied the venue requirements but not vice versa.
Under the current circumstances, the instant version of bankruptcy venue reform legislation is likely to get a much closer look (and maybe even a vote unlike prior attempts). The arguments from both proponents and opponents have not changed but the emotions and political pressures may have. We will keep our readers apprised of the legislation as it moves through Congress.
The District Court for the Southern District of New York recently issued an important decision that provides further support for a holistic analysis when applying the Bankruptcy Code’s “safe harbors.” In Mark Holliday, the Liquidating Trustee of the BosGen Liquidating Trust v. Credit Suisse Securities (USA) LLC, et al., 20 Civ. 5404 (Sept. 13, 2021), the District Court affirmed the Bankruptcy Court’s dismissal of the plaintiff’s state law fraudulent conveyance claims against the defendants as protected from avoidance by the “safe harbors” of Section 546(e) of the Bankruptcy Code. In doing so, the appellate court examined the nature of the “overarching transfer” rather than a distinct element of the transaction as pled in the plaintiff’s complaint.
The claims arose from a 2006 leveraged recapitalization whereby a holding company (“Holdings”) and its operating subsidiary, Boston Generating, LLC (“BosGen”), obtained loans to fund a tender offer and a dividend to interest holders of Holdings. The loans came in the form of two credit facilities extended to BosGen that required it to fund the purchase of certain interests in, and make a distribution to, Holdings’ members. A national bank (“Bank A”) served as “depository” for BosGen and, at the direction of BosGen, received the proceeds of the loans and then transferred them in accordance with funds flow instructions. A portion of those proceeds intended for use in the purchase of the membership interests and distribution was deposited in an account of Holdings at a second bank (“Bank B”). Holdings then directed Bank B to transfer the funds to its account at yet another bank (“Bank C”) for purposes of effecting the payments to the members.
Holdings, BosGen and certain affiliates later filed bankruptcy and confirmed a liquidating chapter 11 plan in August 2012. The plan created a liquidating trust and the liquidating trustee thereafter commenced an adversary proceeding against the defendants. Among other causes of action, the plaintiff sought a ruling that the transfer from Bank A (BosGen’s account) to Bank B (Holdings’ account) should be avoided as a fraudulent transfer. After much legal maneuvering, including the filing of a number of amended complaints, the Bankruptcy Court ultimately dismissed the adversary complaint in June 2020, including the fraudulent conveyance claims. It did so on the basis that such claims were protected by Section 546(e) of the Bankruptcy Code (“Section 546(e)”). Very generally, Section 546(e) protects certain pre-petition transfers from avoidance in a bankruptcy of the transferor — including transfers that are (i) a margin payment, settlement payment or transfer, (ii) made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, and (iii) made in connection with a securities contract, commodity contract, or forward contract. See 11 U.S.C. § 546(e).
On appeal, the District Court considered the holding of the leading case involving a transfer executed in numerous steps, Merit Mgmt. Grp., LP v. FTI Consulting, Inc., 138 S. Ct. 883. The District Court explained that Merit required it to “determine what is the relevant transfer for the 546(e) safe harbor inquiry…” and that it must not “analyze a transfer divorced from its context.” See Holliday at 6. While the District Court acknowledged that Merit holds that the relevant transfer is the one that the plaintiff seeks to avoid, it need not rely on a plaintiff’s interpretation of that transfer – if challenged. Id. Here, the transfer at issue was defined by reference to New York law which guided the District Court to examine an allegedly fraudulent conveyance in the context of the larger plan “viewed as a whole with all its composite implications.” Id. at 7 (citation omitted). The District Court noted that many parties to the recapitalization understood that the loans were extended to BosGen, in part to fund the payments to Holdings’ members. Accordingly, the District Court refused to limit its analysis to the transfer solely from Bank A to Bank B — and determined that the “heart” of case was the leveraged recapitalization and that the real transfer that the plaintiff sought to avoid was that from Bank A to Bank C . Id. This was an important point of distinction, linking the whole (collapsed) transaction to a securities contract (i.e., the tender offer) for the purposes of satisfying the safe harbor contained in Section 564(e). With that critical point settled, the District Court agreed with the Bankruptcy Court’s ruling that the transfer was protected from avoidance as a “settlement payment”, made on behalf of a “financial institution” (which included BosGen as a customer of Bank A, its agent), and made in conjunction with a “securities contract.”
Participation agreements, in the form promulgated by The Loan Syndications and Trading Association, Inc. (LSTA), are widely regarded as dependable vehicles for conveying loan ownership interests from a lender to a participant as “true sales” in the United States. But what if the underlying credit agreement describes the participation as a financing relationship between a lender, as debtor, and participant, as creditor? The answer is unclear as a legal matter, and the existence of such language should give market participants pause if encountered in the loan origination or secondary trading contexts.
On August 31, the LSTA issued a market advisory noting that it was concerned that certain new originations in the U.S. loan market describe participations as “debtor-creditor” relationships. (“Participation Provisions in Credit Agreements Market Advisory,” Loan Syndication and Trading Association, August 31, 2021) This is a significant deviation from the prescribed drafting framework under the LSTA’s forms of credit agreement and model provisions, which generally permits lenders to “sell” loans by participation. The recent increased usage of this language in U.S. credit agreements led the LSTA to recommend that loan market participants carefully review the participation-related transfer provisions found in credit agreements and be aware that deviations from LSTA language could jeopardize sale accounting treatment. We agree with the LSTA’s recommendations.
Under generally accepted accounting principles, one of the requirements for sale accounting treatment is a finding of “legal isolation” – i.e., that a transfer of an asset would put the asset presumptively beyond the reach of the transferor and its creditors, even if the transferor becomes a debtor in bankruptcy or (if it is an insured depository institution) becomes subject to receivership or conservatorship. Underlying this legal isolation issue is whether an asset transfer would, under relevant state and federal law, be held to be a true sale rather than a disguised secured financing (with the seller as de facto borrower, the participant as its creditor and the purportedly sold asset serving as mere collateral). In the case of a transfer of a loan participation, this can be a complex legal question, requiring analysis of a variety of facts and circumstances surrounding a transaction against principles distilled from decades of true sale jurisprudence. Fortunately for market participants today, most routine participations of funded loans documented on LSTA standard participation agreements are not considered controversial and can be accounted as sales without an extensive (and costly) de novo legal review.
That, however, may not be true in the context of a credit agreement with atypical transferability terms – in particular, terms that provide that any participation thereunder is not a sale but rather is a financing between the lender and participant. Such a fact complicates analysis of a participation as a true sale, because when considering whether a true sale exists, relevant case law puts great weight on the parties’ objective intent to execute a true sale. Would, for example, a bankruptcy court doubt that a lender (as transferor under a participation agreement) truly intended to sell its loan interests if the same lender had also agreed (as party to the credit agreement) that any participation creates a debtor-creditor relationship between the seller/lender and the participant? Possibly. Although not necessarily conclusive evidence, it is likely a bad fact weighing against a true sale conclusion. Therefore, any seller seeking sale accounting treatment, or buyer seeking to avoid entanglement in a seller’s potential future insolvency proceeding, should be aware of the risk such debtor-creditor language poses.
Though true sale analyses are complex, the advice for lenders and participants in this context is straightforward:
- Absent a compelling justification, urge deal counsel, agents and arrangers to use LSTA model (or other true sale compliant) language in drafting participation transfer provisions for U.S. credit agreements.
- Prior to consummating secondary market trades that may settle by participation, carefully diligence loan documentation’s transferability provisions for “debtor-creditor” participation language.
- If a credit agreement’s language is problematic and sale by participation remains desired, consult with accounting and legal advisors to determine (1) whether such language introduces the need to obtain a new “true sale” legal opinion to satisfy the legal isolation condition for sale accounting treatment, and (2) if so, whether such an opinion could be obtained after full consideration of the “debtor-creditor” credit agreement language, the terms of the participation agreement and other material facts and circumstances pertaining to the transaction.