Bankruptcy & Restructuring Law Monitor : Bankruptcy Lawyer & Attorney : Cole Schotz Meisel Forman & Leonard Law Firm : NJ, Mid-Atlantic Restructuring & Chapter 11

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 After the bankruptcy court refused to allow the break-up fee, Kelson withdrew its offer on the ground that it was no longer valid and did not participate in the auction process.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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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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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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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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