Third Circuit Clarifies Standard For Allowance of Break-Up Fees in Section 363 Sales

Posted on February 8, 2010 by Kenneth L. Baum

In a recent decision, the United States Court of Appeals for the Third Circuit further defined its standard for awarding a break-up fee to an unsuccessful “stalking horse” bidder for a debtor’s assets. In In re Reliant Energy Channelview LP, ___ F.3d ___, 2010 WL 143678 (C.A. 3 (Del.) 2010), the debtors sought to sell their largest asset, a power plant, pursuant to Section 363 of the Bankruptcy Code. Following a comprehensive marketing process, the debtors accepted a $468 million bid of Kelson Channelview LLC (Kelson). The contract with Kelson simply required the debtors to seek an order approving certain bid protections and procedures, including the payment of a $15 million break-up fee to Kelson, if the bankruptcy court were to require the debtors to hold an auction, which it subsequently did.

In response to the debtors’ request to approve the proposed break-up fee, a potential competing bidder, Fortistar, LLC (Fortistar), argued that it was discouraged from submitting a higher bid by the proposed break-up fee. After the bankruptcy court refused to allow the break-up fee, Kelson withdrew its offer on the ground that it was no longer valid and did not participate in the auction process. The debtors accepted Fortistar’s bid, which exceeded Kelson’s original bid by $32 million, and the bankruptcy court approved the sale of the power plant to Fortistar. Kelson appealed the bankruptcy court’s denial of a break-up fee to the district court, which affirmed the bankruptcy court’s ruling. Kelson then appealed to the Third Circuit.

The court in Reliant noted its decision in Calpine Corp. v. O’Brien Environmental Energy, Inc. (In re O’Brien Environmental Energy, Inc.), 181 F.3d 527 (3d Cir. 1999), where it held that the allowance of a break-up fee was subject to the standard for allowance of an administrative priority claim under Section 503(b) of the Bankruptcy Code; that is, the fees had to be necessary to preserve the value of the bankruptcy estate. In O’Brien, the court ruled that a break-up fee did not meet that standard where the unsuccessful bidder would have bid even without the assurance of a break-up fee (which, in that case, it did).

The court in Reliant further defined the O’Brien standard by ruling that to preserve the value of the estate, the break-up fee must have either induced or preserved a bidder’s bid. The court held that because Kelson did not condition its bid on the provision of a break-up fee, but only required the debtors’ agreement to seek a break-up fee, the fee was not necessary to induce Kelson’s bid. Additionally, the court held that the break-up fee was not necessary to preserve Kelson’s bid because, among other things, it was reasonable to assume that Kelson would not have abandoned its contract with the debtors if no other bidders materialized.

Reliant teaches that buyers of assets in Section 363 sales who seek maximum bid protections, including a break-up fee, should make allowance of those protections a material condition of their contract with a debtor, and specifically provide that failure to obtain court approval of such protections will constitute an event of default under the contract.

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Claimants Fight Subordination

Posted on October 20, 2009 by Laurence May

Over the last several years, there have been a series of decisions rendered by the federal courts of appeals that grappled with the application of §510(b) to a claim that does not readily fall within the statute’s language.  Click here to read about the continuing expansion of §510(b).

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Lawsuit Defendants Get Their Own "Stimulus Package"

Posted on September 21, 2009 by Neil Y. Siegel

Bankruptcy practitioners should be aware of the U.S. Supreme Court’s recent decision in Ashcroft v. Iqbal, 129 S. Ct. 1937, (2009), which confirmed a new, more subjective standard for evaluating whether a complaint complies with Federal Rule of Civil Procedure 8(a)(2). That Rule, which applies to adversary proceedings pursuant to Federal Rule of Bankruptcy Procedure 7008(a)(2), states that a pleading must contain a “short and plain statement of the claim showing that the pleader is entitled to relief.” Since 1957, motions to dismiss for failure to state a claim have been assessed under Conley v. Gibson, 355 U.S. 41, in which the Supreme Court held that “a complaint should not be dismissed unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.” The Conley approach made motions to dismiss a complaint for failure to state a claim very difficult to win. Two years ago, in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the Supreme Court held that Conley’s ‘no set of facts’ standard should be retired, and opted instead for a “plausibility standard.” The pleader now had to amplify a claim with sufficient factual statements so as to render the claim “plausible.” In order to survive a motion to dismiss, a plaintiff must provide “more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do.” Because of apparent doubt among reviewing courts whether Twombly applies in all cases, or just anti-trust cases such as Twombly, the Supreme Court in Iqbal confirmed that the Conley standard no longer applies in any civil case.

Under Twombly/Iqbal, the court embarks on a two-part analysis in determining whether to dismiss a complaint for failure to state a claim. First, the court must accept as true all allegations contained in the complaint, although that tenet does not apply to legal conclusions. Second, the court should consider whether a complaint states a “facially plausible” claim for relief. In turn, determining if a complaint states a plausible claim for relief will be a “context-specific” task that requires the court to “draw on its judicial experience and common sense.” Notably, if the “well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged – but it has not “show[n] – “that the pleader is entitled to relief.” Clearly, this new standard gives trial judges considerable discretion in determining whether a complaint satisfies Rule 8(a).

Bankruptcy courts already have dismissed preference and fraudulent conveyance complaints under the new Rule 8(a) standard. See, e.g., In re Caremerica, Inc., 2009 WL 2227212 (July 23, 2009) (“Caremerica I”), and 409 B.R. 346 (July 28, 2009) (“Caremerica II”). In Caremerica I, after addressing each of the elements of a complaint under Section 547(b) of the Bankruptcy Code, the court found the Trustee’s complaint did not plead sufficient factual allegations to establish a claim for relief that is plausible. Among other things, the trustee did not indicate which of the consolidated debtors initiated the transfers at issue, the complaint did not assert facts supporting the existence of an antecedent debt owed by the debtors to the defendants, the trustee did not allege sufficient facts that insolvency was plausible on the dates transfers to alleged insiders were made outside of the presumed 90-day insolvency period, and the allegations did not establish a reasonable inference of insider status. In Caremerica II the court dismissed the trustee’s constructive fraudulent transfer complaint against a separate defendant under Section 548(a)(1)(B) for not describing the consideration received by each transferor or the debtors’ insolvency at the time of the transfer. Without such factual content, the trustee could not show that his constructive fraud theory was plausible.

This new, more stringent pleadings standard suggests that motions to dismiss undoubtedly will become more prevalent and, to avoid the success of such motions, the factual allegations of a complaint should be drafted carefully and exactingly so as to make a claim for relief plausible.
 

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All Hope May Not Be Lost For a Seller of Goods to an Insolvent Buyer

Posted on August 3, 2009 by Kenneth L. Baum

In these days of economic uncertainty and write-offs, sellers should be aware of their right under Section 2-705 of the Uniform Commercial Code (UCC) to stop the delivery of goods in transit to an insolvent buyer who has not taken physical possession of the goods. “Insolvent,” within the meaning of the UCC, means that a buyer has “…generally ceased to pay debts in the ordinary course of business other than as a result of bona fide dispute ….” In some cases, litigation may be necessary to determine the issue of insolvency. Additionally, a buyer may refuse or defeat a demand to stop goods in transit where (a) it has actually received the goods in question, (b) a bailee of the goods (other than a carrier) acknowledges it is holding the goods for the buyer, (c) a carrier, through reshipment or warehousing, makes such acknowledgment to the buyer, or (d) the buyer has negotiated a negotiable document of title to the goods.

A seller’s right to stop in transit exists even where the buyer has filed for bankruptcy protection, as courts have held that a seller is not required to seek relief from the automatic stay provisions of the Bankruptcy Code before exercising its right to stop delivery. Moreover, because an effective stoppage of delivery divests the buyer of title to the goods at issue, goods purchased, but never received, by a buyer who has filed for bankruptcy protection, never become part of the bankruptcy estate.

Cole Schotz recently represented a client who stopped goods in transit to Fortunoff’s, which purchased a substantial amount of furniture and other merchandise on credit from various overseas sellers shortly before filing a Chapter 11 bankruptcy petition. In many cases, the bill of lading issued by the carrier provided that title to the goods passed to Fortunoff’s when they were loaded for delivery to New York. Upon learning of Fortunoff’s bankruptcy filing, many sellers (including our client), whose shipments had not yet arrived at Fortunoff’s New York warehouse facility, issued notices that they were stopping the shipments in transit pursuant to Section 2-705 of the UCC. The bankruptcy court in Fortunoff’s Chapter 11 case rejected Fortunoff’s argument that the passage of title and the application of the automatic stay rendered the sellers’ demands ineffective, and held that any goods that were the subject of a valid stop in transit demand were not property of Fortunoff’s bankruptcy estate.

As the Fortunoff’s example illustrates, a seller of goods to an insolvent buyer, including a buyer who has filed for bankruptcy protection, who seeks to minimize its losses should consider the stop in transit provisions of the UCC and seek relief in the bankruptcy court to ratify its actions.
 

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Single Asset Real Estate Debtors: Challenges in the Bankruptcy Code

Posted on May 5, 2009 by Warren A. Usatine

Unlike retailers and manufacturers that file for chapter 11 protection, real estate owners and developers must be mindful of the restrictions and special expedited procedures the Bankruptcy Code imposes upon debtors whose estates consist of a single property or project (“Single Asset Real Estate” or “SARE” cases). In those cases, the automatic stay, which typically gives debtors a “breathing spell” from lenders’ collection efforts, terminates ninety (90) days after the bankruptcy filing unless the debtor either files a confirmable plan of reorganization or commences monthly interest payments to its secured lenders. Set forth below is a brief discussion of the relevant statutory provisions and interpreting case law regarding SARE cases.
 

As part of the Bankruptcy Reform Act of 1994, Congress added two new sections to the Bankruptcy Code to expedite single asset real estate cases and enhance the leverage held by secured lenders. First, Congress added section 101(51B) of the Code, which defines “single asset” real estate as:
[R]eal property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of the debtor and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental thereto having aggregate non-contingent, liquidated secured debts in an amount no more than $4,000,000.
 

Second, Congress amended section 362 of the Bankruptcy Code to require that the automatic stay be terminated if the debtor does not file a plan of reorganization or commence monthly interest payments within ninety (90) days of the petition date. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) eliminated the $4 million cap in section 101(51B), expanding the reach of the SARE provisions and making them applicable to much larger projects and entities, including the many public and private homebuilders facing today’s economic pressures.
 

The text of section 101(51B) does not elaborate as to the meaning of the phrases “substantial business” or “other than the business of operating the real property.” Courts interpreting those phrases have benefitted little from the legislative history accompanying the amendments. Without meaningful legislative guidance, courts have focused on whether the real estate is used in the operation of a business or whether it is simply held for “passive” income. Many courts interpreting the 1994 SARE amendments have determined a debtor that actively operates a business on its property, even when the operation of such business centers around the use of a debtor’s property, does not constitute a SARE. See In re CBJ Dev., Inc., 202 B.R. 467 (9th Cir. BAP 1996) (finding that hotel operations were not the mere “operation of a property” because, in addition to operating a gift shop, it required (i) a substantial number of employees; (ii) actively maintaining each of the rooms, (iii) cleaning bed sheets and towels; and (iv) providing basic amenities to guests, specifically phone service); Prairie Hills Golf & Ski Club, Inc., 255 B.R. at 228 (Bankr. D. Neb. 2000) (operation of golf and ski facilities connected to residential land developments is not merely operating the property); Larry Goodwin Golf, Inc., 219 B.R. 391 (Bankr. M.D.N.C. 1997) (operation of a golf course and pool with concession stand is not merely operating the property); In re Khemko, Inc., 181 B.R. 47 (Bankr. S.D. Ohio 1995) (marina not a single asset real estate debtor under section 101(51B) because, in addition to providing for the mooring of boats, the marina also stored, repaired and winterized boats, provided showers and a pool, sold gas, and sold concessions); and Whispering Pines Estate, Inc., 341 B.R. 134 (Bankr. D. N.H. 2006) (debtor, which operated an 89-room hotel, conducted operations in connection therewith that were “sufficiently active in nature to constitute a business other than the mere operation of property”).
 

As noted above, however, the elimination of the $4 million cap as part of the 2005 BAPCPA amendments have caused SARE issues to appear with somewhat greater frequency in more substantial cases. Of note in these troubled times for homebuilders is Kara Homes, Inc. v. Nat’l City Bank (In re Kara Homes, Inc.), 363 B.R. 399 (Bankr. D. N.J. 2007). There, a parent entity and several of its subsidiaries filed chapter 11 cases. The parent oversaw the overall residential development business and each debtor subsidiary owned real estate on which it developed residential projects. None of the debtor subsidiaries had its own employees or a separate permanent facility from which to operate. The court found each debtor subsidiary was a SARE because its business operations “[we]re merely incidental to their efforts to sell the homes or condominium[s] and thus did not constitute substantial business.”
 

In contrast, however, is In re Scotia Dev., LLC, 375 B.R. 764 (Bankr. S.D. Tex. 2007). There, the court adopted the “active-versus-passive” criterion in addressing whether a timber harvester was a SARE debtor. The court made detailed findings regarding the debtor’s activities and noted those activities are extensive and require hands-on supervision by teams of experts. Taking into account those extensive operations, the court concluded the debtor did not constitute a SARE. The court applied a “practical approach” to construing section 101(51B) of the Bankruptcy Code, and followed the approach of prior courts that “includ[ed] within its [section 101(51B)] ambit only those debtors who have no revenue from their property except the passive collection of rent from tenants and excluding from its reach those entities that undertake and pursue various sorts of active economic, commercial, and business activities on the property.”
 

In sum, the restrictions imposed by the SARE provisions of the Bankruptcy Code are meaningful and create material hurdles for real estate debtors. The ways in which courts apply those provisions will be noteworthy as more real estate entities consider chapter 11 as part of their restructuring strategies.

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"Stub Rent" Considered Administrative Expense Obligation by Delaware District Court

Posted on May 5, 2009 by Ilana Volkov & Erin E. Wietecha

The United States District Court for the District of Delaware, in Goody’s Family Clothing, Inc. et al. v. Mountaineer Prop. Co. II, LLC, et al. (In re Goody’s Family Clothing, Inc. et al.), 2009 WL 903370 (D. Del. March 31, 2009), held that “stub” rent owed to commercial landlords should be accorded administrative expense priority under Section 503(b)(1) of the Bankruptcy Code. “Stub” rent is a bankruptcy term of art that means rent due for the period from the date the bankruptcy case is commenced through the end of the month in which the case was filed. In so ruling, the District Court swiftly distinguished the Third Circuit’s decision in In re Montgomery Ward Holding Corp., 268 F.3d 205, 209 (3d Cir. 2001), and ruled that Section 365 of the Bankruptcy Code is not the exclusive remedy for commercial landlords to obtain payment of “stub” rent. The Goody’s Court ruled, however, that while the “stub” rent obligation constituted an administrative expense claim, payment did not have to be made immediately. That is, payment could be made pursuant to a confirmed Chapter 11 plan.

Section 365(d)(3) of the Bankruptcy Code provides that a debtor-in-possession must timely perform all the obligations of the debtor under an unexpired commercial real property lease arising after the order for relief is entered until such lease is assumed or rejected, notwithstanding section 503(b)(1) of the Bankruptcy Code. As to payment of “stub” rent, there is a split of authority whether such obligation should be deemed a pre-petition or post-petition obligation of the debtor-tenant. Some courts have adopted the “billing date” approach based on their view that an obligation to pay rent arises on the day that rent is due, while others have adopted the “accrual date” approach based on the days the tenant occupies the leased premises. In Montgomery Ward, the Third Circuit adopted the “billing date” approach when confronted with the issue of whether real estate taxes billed to the tenant under an unexpired lease after the bankruptcy filing had to be paid in full, even though a portion of the taxes were attributable to the pre-petition period. The Third Circuit required payment of the entire real estate tax bill because it was “billed” after the bankruptcy filing.

Technically, under Montgomery Ward’s “billing date” approach, the “stub” rent in Goody’s would have constituted a pre-petition claim. However, the Goody’s Court relied on Section 503(b) of the Bankruptcy Code to grant the commercial landlords an administrative expense claim for their “stub” rent. That statute provides that an administrative claim should be allowed for the “actual, necessary costs and expenses of preserving the estate.” The Goody’s Court held that because the debtors were occupying leased commercial premises after the bankruptcy filings and were using them to conduct “profitable” store closing sales, Section 503(b) entitled them to an administrative expense claim for the “stub” rent. This is a significant victory for commercial landlords, and one debtors’ counsel should consider when determining the date on which a bankruptcy filing should be commenced.

On April 27, 2009, the Debtors filed a notice of appeal in the District Court, invoking their right to have the Third Circuit review the Delaware District Court's decision. The Third Circuit case number is 09-2168.

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Second Circuit Finds Termination Premiums Non-Dischargeable in Bankruptcy

Posted on May 5, 2009 by Felice R. Yudkin

On April 8, 2009, the United States Court of Appeals for the Second Circuit, reversing a ruling by the United States Bankruptcy Court for the Southern District of New York, concluded that certain “termination premiums” due to the Pension Benefit Guaranty Corporation (“PBGC”) are not contingent pre-petition claims subject to discharge in a Chapter 11 reorganization. The Second Circuit’s decision is of great import because debtors that terminate their pension plans after filing for bankruptcy may no longer be able to escape paying significant claims to the PBGC.

 

Background

On February 28, 2006, the Deficit Reduction Act of 2005 (“DRA”) was enacted. The DRA requires employers that terminate qualified pension plans to pay annual “termination premiums” to the PBGC equal to $1,250 per beneficiary for three years after the termination. A “Special Rule,” however, applies to termination of pension plans in bankruptcy proceedings. That “Special Rule” provides that termination premiums begin to accrue on the date of the discharge or dismissal of the employer’s bankruptcy case.

Flatware manufacturer Oneida Ltd. commenced a Chapter 11 case in 2006. At the outset of its case, Oneida moved to terminate its three underfunded pension plans. After confirming its plan of reorganization, Oneida sought a declaratory judgment that the PBGC’s claims for termination premiums were contingent pre-petition claims that were discharged by Oneida’s plan of reorganization. The Bankruptcy Court for the Southern District of New York agreed with Oneida. The PBGC appealed the Bankruptcy Court’s ruling and the Second Circuit granted the parties’ joint request to hear the appeal directly under 28 U.S.C. § 158(d)(2).

 

The Second Circuit’s Decision

The Second Circuit reversed the lower court’s ruling. The Second Circuit stated that in order to have a valid bankruptcy claim, a party must have a right to payment that arose pre-petition, which right must be determined in accordance with non-bankruptcy law. The Second Circuit, relying on the “Specific Rule,” found that the PBGC’s right to payment of termination premiums does not arise until after the employer is discharged from bankruptcy. As such, the Second Circuit held that the PBGC’s termination premium claim is not a pre-petition claim subject to discharge in Chapter 11. The Second Circuit remanded the case to the Bankruptcy Court for further proceedings consistent with its ruling.

 

Conclusion

The Oneida ruling is the first published decision on the issue. Companies seeking to use the bankruptcy process to terminate their pension obligations must now squarely address whether termination should occur before the bankruptcy filing in view of the Oneida ruling. This decision cannot be taken lightly as pre-petition pension plan termination might adversely impact a company’s relationship with its employees.
 

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