Rumors of another recession multiplied as the tumultuous second year of the Trump administration came to a close. Highlights of 2018 included a simmering trade war with China; political upheaval after the House of Representatives was retaken by Democrats in the midterm elections; mayhem in financial markets; and, in December, the beginning of the longest government shutdown in U.S. history, triggered by lawmakers' refusal to provide $5.7 billion in funding for a U.S.-Mexican border wall.
Despite the political roller-coaster ride and indications of trouble on the horizon, 2018 was a good year economically for the U.S., with strong growth in the economy (2.8 percent); low inflation (2.2 percent); and the lowest unemployment rate in 50 years (3.9 percent).
These developments prompted the U.S. Federal Reserve to raise its benchmark federal-funds interest rate in December 2018 to a band of 2.25 to 2.50 percent, the highest rate since the spring of 2008, marking the fourth increase for the benchmark rate during the year.
However, as corporate tax revenues sharply declined after the 2017 tax cuts took effect, the federal budget deficit widened in fiscal year (the period from October 1 through September 30 (the "FY")) 2018 to $779 billion, up 17 percent from the $668 billion deficit in FY 2017. Moreover, the gross national debt increased by more than $2 trillion during the last two years, reaching $22 trillion at the end of 2018.
U.S. stock markets closed out 2018 with their steepest annual declines since the financial crisis, reflecting growing unease among investors about the health of the nearly decade-long bull run. For the year, the Dow Jones Industrial Average was down 5.6 percent, the S&P 500 was off 6.2 percent, and the NASDAQ Composite finished the year down 3.9 percent.
Business Bankruptcy Filings
According to the Administrative Office of the U.S. Courts, business bankruptcy filings during calendar year ("CY") 2018 totaled 22,232, down from 23,157 in CY 2017. Chapter 11 filings declined nearly 5 percent to 7,095 in CY 2018, from 7,442 in CY 2017. Of the CY 2018 chapter 11 filings, 6,078 chapter 11 cases were filed by businesses and 1,017 cases were filed by non-business debtors. The most frequent venues for business chapter 11 filings in CY 2018 were the Southern District of New York (626 cases), the District of Delaware (615 cases), and the Southern District of Texas (453 cases).
One hundred petitions seeking recognition of a foreign bankruptcy proceeding under chapter 15 of the Bankruptcy Code were filed in CY 2018, compared to 81 in CY 2018. The venues with the greatest number of chapter 15 filings in CY 2018 were the Southern District of New York (59 cases) and the Southern District of Florida (20 cases). Four municipal debtors filed for chapter 9 protection in CY 2018, compared to seven in CY 2017.
Research firm Reorg reported that there were 336 chapter 11 filings by companies with at least $10 million in liabilities during 2018, down 4.5 percent from the 352 filings in 2017. Retail filings (consisting of companies in the consumer discretionary and consumer staples sectors) led the pack, with 105 filings, followed by companies in the financial (63 filings), healthcare (45 filings), energy (36 filings), and industrials (35 filings) sectors. Forty-five of those chapter 11 cases (13 percent) were prepackaged or prenegotiated.
Public Company Bankruptcy Filings
According to data provided by New Generation Research, Inc.'s BankruptcyData.com, bankruptcy filings for "public companies" (defined as companies with publicly traded stock or debt) fell for the second year in a row in 2018, with the volume of prepetition assets halving from 2017 to its lowest level since 2013.
The number of public company bankruptcy filings in 2018 was 58, compared to 71 in 2017. At the height of the Great Recession, 138 public companies filed for bankruptcy in 2008 and 211 in 2009.
The combined asset value of the 58 public companies that filed for bankruptcy in 2018 was $52 billion, compared to $106.9 billion in 2017. By contrast, the 138 public companies that filed for bankruptcy in 2008 had prepetition assets valued at $1.16 trillion in aggregate.
Companies in the oil and gas/energy and retail and supermarket sectors led the charge in public company bankruptcy filings in 2018, with 22 percent (13 cases) and 17 percent (10 cases), respectively, of the year's 58 public bankruptcies. Other sectors with a significant number of public filings in 2018 included chemicals and allied products (nine cases), healthcare and medical (five cases), and computers and software (three cases).
Five of the 10 largest public company bankruptcy filings in 2018 (and seven of the 20 largest) came from the retail and supermarket sector. The second-most-represented sector was oil and gas/energy, with two cases in the Top 10 and five in the Top 20.
The year 2018 added 12 public company names to the billion-dollar bankruptcy club (measured by value of assets), compared to 22 in 2017. However, the largest public company bankruptcy filing of 2018—media and entertainment giant iHeartMedia, Inc., with $12.8 billion in assets—did not crack the list of the 40 largest public bankruptcy filings of all time. By asset value, the remaining public companies among the 10 largest bankruptcy filings in 2018 were Sears Holdings Corp. ($7.2 billion in assets); FirstEnergy Solutions Corp. ($5.5 billion in assets); Claire's Stores, Inc. ($2 billion in assets); Southeastern Grocers, LLC (a.k.a. Winn-Dixie, BI-LO, and Harveys Supermarkets) ($1.8 billion in assets); Aegean Marine Petroleum Network Inc. ($1.8 billion in assets); EV Energy Partners, L.P. ($1.6 billion in assets); The Bon-Ton Stores, Inc. ($1.5 billion in assets); Westmoreland Coal Co. ($1.4 billion in assets); and Tops Holding II Corp. ($1 billion in assets).
Twenty-five public and private companies with assets valued at more than $1 billion obtained confirmation of chapter 11 plans or exited from bankruptcy in 2018. Continuing a trend begun in 2012, many more of these companies (19) reorganized than were liquidated or sold.
Seven, or 12 percent, of the 58 public company bankruptcy filings in 2018 were prenegotiated or prepackaged chapter 11 cases, down from 23 percent (16 cases) in 2017.
Territorial and Municipal Debt
The ongoing debt crisis in Puerto Rico continued to grab headlines in 2018. In May 2017, Puerto Rico's oversight board filed a petition under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act in the largest-ever bankruptcy filing by a governmental entity in the United States. Title III filings for several Puerto Rico instrumentalities followed shortly afterward. The filings ignited new rounds of litigation with Puerto Rico's bondholders, which collectively hold more than $74 billion of Puerto Rico's $144 billion in debt. The commonwealth's financial woes have been compounded by the damage and humanitarian crisis wrought in 2017 by Hurricane Maria, from which the island territory has yet to recover.
In June 2018, the Puerto Rico Sales Tax Financing Corporation (known as COFINA) reached a milestone settlement with municipal bondholders and other creditors regarding claims to roughly $18 billion in pledged Puerto Rico sales tax collections. The settlement was ultimately incorporated into a plan of adjustment for COFINA that was confirmed by the court on February 4, 2019.
Puerto Rico and its creditors also reached an out-of-court agreement in 2018 to restructure approximately $4 billion in debt issued by the commonwealth's Government Development Bank.
The City of Detroit exited decades of state financial oversight in 2018, a development indicating that the city has made strides toward reversing the long economic and fiscal decline that propelled it into the largest municipal bankruptcy filing ever. Detroit filed its chapter 9 case in 2013 and obtained confirmation of a plan of adjustment in 2014 that eliminated more than $7 billion in debt. Established in 2014 to monitor the Motor City, Detroit's Financial Review Commission voted unanimously in April 2018 to end its oversight of a city that has been under some form of outside supervision since 1975. With its landmark reorganization, Detroit arrested a downward spiral that resulted from decades of population loss, declining tax revenue, and the disappearance of automobile-industry jobs.
In a development last seen in 2006, the Federal Deposit Insurance Corporation did not shutter any banks in 2017. By comparison, there were 140 bank failures in 2009 and 157 in 2010, during the height and immediate aftermath of the Great Recession.
Notable Business Bankruptcy Rulings in 2018
In bankruptcy cases, appellees often invoke the doctrine of "equitable mootness" as a basis for precluding appellate review of an order confirming a chapter 11 plan. In Bennett v. Jefferson County, Alabama, 899 F.3d 1240 (11th Cir. 2018), the U.S. Court of Appeals for the Eleventh Circuit ruled as a matter of first impression that the doctrine applies in chapter 9 cases. According to the Eleventh Circuit panel, "[T]he correct result is to join the Sixth Circuit and the Ninth Circuit B.A.P. in allowing equitable mootness to apply in the Chapter 9 context." The court held that an appeal filed by county sewer ratepayers of an order confirming a chapter 9 plan of adjustment was equitably moot because the ratepayers failed to seek a stay pending appeal and because the plan had been substantially consummated. The panel also concluded that a chapter 9 plan subjecting ratepayers to rate increases over time, "instead of forcing them to bear the financial pain all at once, does not transmogrify it into one that per se violates the ratepayers' constitutional rights."
Also as a matter of first impression, the U.S. Court of Appeals for the Ninth Circuit similarly relied on the doctrine to dismiss an appeal of an order confirming a chapter 9 plan of adjustment in In re City of Stockton, California, 909 F.3d 1256 (9th Cir. 2018). The court ruled that an appeal from an unstayed chapter 9 plan confirmation order must be dismissed as equitably moot where the appellant had not sought a stay from the bankruptcy court or a bankruptcy appellate panel, where the city's plan had been substantially consummated, and where the relief sought by the appellant—vacatur of the confirmation order based on the plan's failure to provide for an alleged $1 million Takings Clause claim—would completely knock the props out from under the plan and undermine settlements negotiated with unions, pension plan participants and retirees, and other creditors. "Adamantly" dissenting, one judge on the three-judge panel would have ruled that a Takings Clause claim for just compensation under the Fifth and Fourteenth Amendments is not subject to the bankruptcy power and is automatically excepted from discharge, regardless of whether the appeal otherwise would be dismissed as equitably moot.
In In re Old Cold LLC, 879 F.3d 376 (1st Cir. 2018), the U.S. Court of Appeals for the First Circuit ruled that the U.S. Supreme Court's decision in Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017), which invalidated creditor distributions that deviate from the Bankruptcy Code's priority scheme as part of a "structured dismissal," does not apply to an asset sale under section 363(b) of the Bankruptcy Code. Instead, the court of appeals applied section 363(m) of the Bankruptcy Code to render statutorily moot an appellate challenge to an asset sale to a good-faith purchaser. Section 363(m) moots any appeal of an order approving a sale of bankruptcy estate assets to a good-faith purchaser unless the sale order has been stayed pending appeal.
In Tanguy v. West (In re Davis), 2018 WL 4232063 (5th Cir. Sept. 5, 2018), the U.S. Court of Appeals for the Fifth Circuit revisited the circumstances under which section 363(m) of the Bankruptcy Code moots an appeal of a bankruptcy court's order approving a sale of assets. The Fifth Circuit reaffirmed its adherence to the majority rule on the issue, ruling that, absent evidence that the purchaser did not acquire the property in good faith, the challengers' failure to obtain a stay pending appeal moots any appeal of a sale order. The court also held that the challengers abandoned any argument that the appeal was not moot by failing to raise it before the bankruptcy court.
Avoidance Actions—Extraterritoriality of Avoidance Laws
In In re CIL Ltd., 582 B.R. 46 (Bankr. S.D.N.Y. 2018), amended on reconsideration, 2018 WL 3031094 (Bankr. S.D.N.Y. June 15, 2018), the U.S. Bankruptcy Court for the Southern District of New York, disagreeing with other courts both within and outside its own district, ruled that the "transfer of an equity interest in a U.K. entity to a Marshall Islands entity was a foreign transfer" and that the Bankruptcy Code's avoidance provisions do not apply extraterritorially because "[n]othing in the language of sections 544, 548 and 550 of the Bankruptcy Code suggests that Congress intended those provisions to apply to foreign transfers." Opposing views on this issue among courts in the Second Circuit may soon be resolved in an appeal pending before the court of appeals in Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC (In re Bernard L. Madoff Investment Securities LLC), 513 B.R. 222 (S.D.N.Y. 2014), appeal filed, No. 17-2992 (2d Cir. Sept. 27, 2017) (oral argument on Nov. 26, 2018). In Madoff, the U.S. District Court for the Southern District of New York ruled that section 550 of the Bankruptcy Code cannot be used to recover stolen funds from a subsequent foreign transferee, given the presumption against extraterritorial application of U.S. statutes.
Avoidance Actions—Safe Harbor for Certain Securities Transactions
In Merit Management Group LP v. FTI Consulting Inc., 138 S. Ct. 883 (2018), the U.S. Supreme Court resolved a long-standing circuit split over the scope of the Bankruptcy Code's "safe harbor" provision exempting certain securities transaction payments from avoidance as fraudulent transfers. The unanimous Court held that section 546(e) of the Bankruptcy Code does not protect transfers made through a financial institution to a third party, regardless of whether the financial institution had a beneficial interest in the transferred property. Instead, the relevant inquiry is whether the transferor or the transferee in the transaction the avoidance of which is sought is itself a financial institution (i.e., a bank, broker, or "financial participant"). Courts in the Second and Third Circuits, which preside over the greatest volume of cases involving transactions that may implicate the section 546(e) safe harbor, have long ruled to the contrary.
In Fairfield Sentry Ltd. v. Amsterdam (In re Fairfield Sentry Ltd.), 2018 WL 6431741 (Bankr. S.D.N.Y. Dec. 6, 2018), the bankruptcy court ruled that the safe harbor in section 546(e) applies extraterritorially, even though the plaintiffs were foreign liquidators suing in the chapter 15 case of a British Virgin Islands ("BVI") company to avoid under BVI law redemption payments made abroad to feeder funds of Bernard Madoff's defunct brokerage firm. The court rejected the argument that, because the district court in Madoff (discussed above) ruled that the Bankruptcy Code's avoidance provisions do not apply extraterritorially, the safe harbor should also have no extraterritorial application. Instead, the court concluded that another provision—section 561(d) of the Bankruptcy Code—makes the safe harbor applicable in chapter 15 cases even if avoidance of a non-U.S. transfer is sought under non-U.S. law. Section 561(d) provides in substance that any provisions in the Bankruptcy Code relating to securities contracts (and certain other types of contracts) "shall apply in a chapter 15 case" to limit avoidance powers to the same extent as in a chapter 7 or chapter 11 case. However, in view of the Supreme Court's ruling in Merit Management (discussed above), the court stopped short of invoking the safe harbor until it has an opportunity to decide whether each transferor was a "financial participant."
Avoidance Actions—Preferential Transfers
In Kaye v. Blue Bell Creameries, Inc. (In re BFW Liquidation, LLC), 899 F.3d 1178 (11th Cir. 2018), the U.S. Court of Appeals for the Eleventh Circuit broadened the scope of section 547(c)(4) of the Bankruptcy Code's "subsequent new value" defense against preference actions by holding that the provision applies to all new value supplied by the creditor during the preference period and not merely to new value that remains unpaid on the bankruptcy petition date. In adopting this approach, the Eleventh Circuit joined the Fourth, Fifth, Eighth, and Ninth Circuits in applying a more expansive reading of section 547(c)(4).
Chapter 11 Plans—Disqualification of Votes
In Pacific Western Bank v. Fagerdala USA-Lompoc, Inc. (In re Fagerdala USA-Lompoc, Inc.), 891 F.3d 848 (9th Cir. 2018), the U.S. Court of Appeals for the Ninth Circuit reexamined the circumstances under which a vote on a chapter 11 plan can be disallowed, or "designated," under section 1126(e) of the Bankruptcy Code because it had been cast in bad faith. The court ruled that a bankruptcy court erred in designating votes cast by a secured creditor who purchased certain unsecured claims for the purpose of blocking confirmation of the debtor's chapter 11 plan. According to the Ninth Circuit, a bankruptcy court may not designate claims for bad faith simply because: (i) a creditor offers to purchase only a subset of available claims in order to block a plan of reorganization; and/or (ii) blocking the plan will adversely impact the remaining creditors. "[A]t a minimum," the court wrote, there must be some evidence that the creditor is "seeking to secure some untoward advantage over other creditors for some ulterior motive."
Chapter 11 Plans—Cramdown
In Law Debenture Trust Co. of New York v. Tribune Media Co. (In re Tribune Media Co.), 587 B.R. 606 (D. Del. 2018), appeal filed, No. 18-2909 (3d Cir. Sept. 4, 2018), the U.S. District Court for the District of Delaware ruled that, under a plain reading of section 1129(b)(1) of the Bankruptcy Code, a cramdown chapter 11 plan need not recognize the priority set forth in a subordination agreement between senior and subordinated bondholders. Section 1129(b)(1) provides that, "[n]otwithstanding section 510(a)" of the Bankruptcy Code (recognizing contractual subordination agreements in bankruptcy), a nonconsensual chapter 11 plan may be confirmed over the objection of an impaired dissenting class of creditors only if the plan does not discriminate unfairly (among other requirements). The court concluded that, because the percentage difference between the senior bondholders' distribution share under the plan versus the outcome under the subordination agreement was immaterial, the plan's treatment of the senior bondholders' claims was not presumed to constitute unfair discrimination.
Chapter 11 Plans—Retiree Benefits
In In re Walter Energy, Inc., 2018 WL 6803736 (11th Cir. Dec. 27, 2018), the U.S. Court of Appeals for the Eleventh Circuit ruled that section 1114 of the Bankruptcy Code authorizes a bankruptcy court to terminate a debtor-employer's statutory obligation under the Coal Industry Retiree Health Benefit Act of 1992 (the "Coal Act") to pay premiums for lifetime employee healthcare benefits when the bankruptcy court finds that such termination is necessary for the coal company to sell its assets as a going concern and to avoid piecemeal liquidation. The Eleventh Circuit concluded that: (i) the bankruptcy court had jurisdiction to terminate the debtor-employer's obligation to pay premiums owed under its employee/retiree benefit plan because such premiums do not qualify as taxes for purposes of the Anti-Injunction Act; (ii) even if such premiums did qualify as taxes, an exception to the Anti-Injunction Act applies because the debtor had no available alternative remedy; (iii) the premiums qualified as "retiree benefits" under section 1114 even though the obligation to pay them was statutory rather than contractual; (iv) in enacting the Coal Act, Congress did not express a "clear and manifest" intent to bar bankruptcy courts from modifying such premiums; and (v) the term "reorganization" as used in section 1114(g)(3) refers both to restructurings and liquidations under chapter 11.
The U.S. Bankruptcy Court for the Southern District of Texas came to the same conclusion in Trustees of United Mine Workers of Am. 1992 Benefit Plan v. Westmoreland Coal Co. (In re Westmoreland Coal Co.), 2018 WL 6920227 (Bankr. S.D. Tex. Dec. 29, 2018). The bankruptcy court certified a direct appeal of its ruling to the U.S. Court of Appeals for the Fifth Circuit.
Chapter 11 Plans—Senior Class Gifting
In Hargreaves v. Nuverra Environmental Solutions Inc. (In re Nuverra Environmental Solutions Inc.), 590 B.R. 75 (D. Del. 2018), the U.S. District Court for the District of Delaware affirmed a bankruptcy court order confirming a nonconsensual chapter 11 plan that included "gifted" consideration from a senior secured creditor to fund unequal distributions to two separate classes of unsecured creditors. The court also ruled that, even though the appeal was equitably moot, the plan's separate classification and differing treatment of unsecured noteholders and trade creditors: (i) did not unfairly discriminate between, or improperly classify, the two unsecured classes because there was a rational basis for the classification scheme; and (ii) were "fair and equitable" because they did not constitute "vertical gifting" that violated applicable precedent and they promoted the debtor's reorganization.
Chapter 11 Plans—Third-Party Releases
In Opt-Out Lenders v. Millennium Lab Holdings II, LLC (In re Millennium Lab Holdings II, LLC), 591 B.R. 559 (D. Del. 2018), the U.S. District Court for the District of Delaware affirmed a bankruptcy court's ruling that it had the constitutional authority to grant nonconsensual third-party releases in an order confirming the chapter 11 plan of a laboratory testing company. In so ruling, the court rejected an argument made by a group of creditors that a provision in the plan releasing racketeering claims against the debtor's former shareholders was prohibited by the U.S. Supreme Court's 2011 ruling in Stern v. Marshall, 564 U.S. 462 (2011), which limited claims that can be finally adjudicated by a bankruptcy judge. The court concluded that Stern does not apply because the "operative proceeding" before the court was a chapter 11 plan confirmation proceeding rather than litigation of the racketeering claims.
The U.S. District Court for the Southern District of New York reached the same conclusion in Lynch v. Lapidem Ltd. (In re Kirwan Offices SARL), 592 B.R. 489 (S.D.N.Y. 2018). In affirming an order confirming a cramdown chapter 11 plan that enjoined arbitration of claims over whether the bankruptcy filing was authorized, the court ruled that "[a] bankruptcy court acts pursuant to its core jurisdiction when it considers the involuntary release of claims against a third-party non-debtor in connection with the confirmation of a proposed plan of reorganization, which is a statutorily defined core proceeding."
Chapter 11 Plans—Treatment of Secured Claims and Acceptance
In Grasslawn Lodging, LLC v. Transwest Resort Properties Inc. (In re Transwest Resort Properties, Inc.), 881 F.3d 724 (9th Cir. 2018), the U.S. Court of Appeals for the Ninth Circuit ruled that a cramdown chapter 11 plan need not provide a due-on-sale clause for an undersecured creditor who elects to be treated as fully secured under section 1111(b)(2) of the Bankruptcy Code. It also ruled, as a matter of first impression among the circuits, that section 1129(a)(10)'s impaired class acceptance requirement applies on a "per plan" rather than a "per debtor" basis.
Claims—Transfers and Allowance
In In re Woodbridge Group of Companies, LLC, 590 B.R. 99 (Bankr. D. Del. 2018), the U.S. Bankruptcy Court for the District of Delaware ruled that, because an anti-assignment clause in a promissory note was enforceable under state law, the associated claim asserted in bankruptcy by the purchaser of the note must be disallowed. The court noted, among other things, that "[t]he evidence does not support the claims trader's argument that enforcing the anti-assignment clause would disrupt the market."
In In re Caesars Entertainment Operating Co., Inc., 588 B.R. 32 (Bankr. N.D. Ill. 2018), the U.S. Bankruptcy Court for the Northern District of Illinois disallowed assigned tort and contract claims because the tort claims were unassignable under applicable non-bankruptcy law and because, pursuant to a purchase and sale agreement, the contract claims could not be assigned without consent. The court also held that Rule 3001(e) of the Federal Rules of Bankruptcy Procedure, which establishes procedures for claims transfers, does not create substantive rights for claims transferees.
In In re Westinghouse Electric Co. LLC, 2018 WL 3655702 (Bankr. S.D.N.Y. Aug. 1, 2018), the U.S. Bankruptcy Court for the Southern District of New York ruled that, because a series of email exchanges between the holder and the purported purchaser of a claim did not create a binding contract under applicable non-bankruptcy law, the notice of transfer of the claim should be canceled and the original holder recognized as the claimant. The court rejected the argument that customs in the claims trading industry demanded a contrary ruling, noting that industry participants "ought to be clear and direct in setting forth their agreements in the emails they exchange," especially when dealing with less experienced counterparties.
Creditors' Rights—Restrictions on Borrower's Bankruptcy Filing
In Franchise Services of North America, Inc. v. Macquarie Capital (USA), Inc. (In re Franchise Services of North America, Inc.), 891 F.3d 198 (5th Cir. 2018), the U.S. Court of Appeals for the Fifth Circuit affirmed a bankruptcy court order dismissing a chapter 11 case filed by a corporation without obtaining—as required by its corporate charter—the consent of a preferred shareholder that was also controlled by a creditor of the corporation. The Fifth Circuit ruled that: (i) state law determines who has the authority to file a voluntary bankruptcy petition on behalf of a corporation; (ii) federal law does not strip a bona fide equity holder of its preemptive voting rights merely because it is also a creditor; and (iii) the preferred shareholder-creditor was not a controlling shareholder under applicable state law such that it had a fiduciary duty to the corporation that would impact any decision to approve or prevent a bankruptcy filing.
Cross-Border Bankruptcies—Chapter 15 Recognition
In Halo Creative & Design Ltd. v. Comptoir Des Indes Inc., 2018 WL 4742066 (N.D. Ill. Oct. 2, 2018), the U.S. District Court for the Northern District of Illinois denied a motion for a stay of U.S. litigation in light of the pendency of the defendant's Canadian bankruptcy proceeding because a U.S. bankruptcy court had not recognized the Canadian bankruptcy under chapter 15 of the Bankruptcy Code.
Executory Contracts and Unexpired Leases—Assumption, Rejection, and Assignment
In Mission Product Holdings, Inc. v. Tempnology, LLC (In re Tempnology, LLC), 879 F.3d 389 (1st Cir. 2018), the U.S. Court of Appeals for the First Circuit ruled that the rejection of a trademark license in bankruptcy means that the licensee loses the ability to use the licensed intellectual property because trademarks are not among the categories of "intellectual property" afforded special protection under the Bankruptcy Code. In so ruling, the First Circuit effectively embraced the approach articulated by the Fourth Circuit in Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc. (In re Richmond Metal Finishers Inc.), 756 F.2d 1043 (4th Cir. 1985), and rejected the contrary approach endorsed by the Seventh Circuit—the only other court of appeals that has directly addressed the issue—in Sunbeam Prods., Inc. v. Chicago Am. Manuf., LLC, 686 F.3d 372 (7th Cir. 2012), cert. denied, 133 S. Ct. 790 (2012). The U.S. Supreme Court agreed on October 26, 2018, to review a portion of the First Circuit's ruling and has scheduled the case for argument on February 20, 2019. See Mission Product Holdings, Inc. v. Tempnology, LLC, 2018 WL 2939184 (U.S. Oct. 26, 2018).
In a ruling with potentially wide-ranging implications in intercreditor disputes and intercreditor agreement drafting and negotiations, the U.S. District Court for the Southern District of New York in In re MPM Silicones, L.L.C., 2018 WL 6324842 (S.D.N.Y. Nov. 30, 2018), as amended, 2019 WL 121003 (S.D.N.Y. Jan. 4, 2019), upheld a bankruptcy court ruling dismissing intercreditor actions filed by a debtor's first-lien and 1.5-lien noteholders seeking to hold second-lien noteholders accountable for alleged losses resulting from their votes accepting, and the bankruptcy court's confirmation of, the debtor's cramdown chapter 11 plan, which distributed new equity to second-lien noteholders. Because the second-lien noteholders wore both "secured and unsecured hats" in the case, the district court affirmed the bankruptcy court's finding that many of the second-lien noteholders' actions in the case were permitted by a provision of the intercreditor agreement allowing the second-lien noteholders to exercise rights as unsecured creditors. According to the district court, the "growing consensus is that agreements that seek to limit or waive junior noteholders' voting rights must contain express language to that effect."
The district court also held that, where a secured lender's liens are reinstated under a chapter 11 plan providing the secured lender with a stream of payments having a present value equal to the value of the lender's collateral, the secured lender's lien does not extend to the reorganized equity issued under the chapter 11 plan. Thus, the distribution under the plan of new equity to the second-lien noteholders did not violate the intercreditor agreement.
Power of Bankruptcy Courts—Substantive Consolidation
In Official Committee of Unsecured Creditors v. Archdiocese of St. Paul and Minneapolis (In re Archdiocese of St. Paul and Minneapolis), 888 F.3d 944 (8th Cir. 2018), the U.S. Court of Appeals for the Eighth Circuit affirmed lower court rulings that the assets of parishes and other entities associated with a Catholic archdiocese were not, by means of "substantive consolidation," available to fund bankruptcy settlements with clergy sexual-abuse victims. According to the Eighth Circuit, a bankruptcy court's authority to issue "necessary or appropriate" orders under section 105 of the Bankruptcy Code does not permit it to order substantive consolidation of the assets and liabilities of a debtor archdiocese with the assets and liabilities of nondebtor entities who also operated as nonprofits, because the remedy would contravene the prohibition of involuntary bankruptcy filings against nonprofits.
From the Top in 2018
The U.S. Supreme Court issued four rulings in 2018 involving issues of bankruptcy law.
In Merit Management Group LP v. FTI Consulting Inc., 138 S. Ct. 883 (2018), the Court issued a highly anticipated ruling resolving a long-standing circuit split over the scope of the Bankruptcy Code's "safe harbor" provision exempting certain securities transaction payments from avoidance as fraudulent transfers. The unanimous Court held that section 546(e) of the Bankruptcy Code does not protect transfers made through a financial institution to a third party, regardless of whether the financial institution had a beneficial interest in the transferred property. Instead, the relevant inquiry is whether the transferor or the transferee in the transaction the avoidance of which is sought is itself a financial institution.
In U.S. Capital Bank N.A. v. Village at Lakeridge, LLC, 138 S. Ct. 960 (2018), the Court held that an appellate court should apply a deferential standard of review to a bankruptcy court's decision as to whether a creditor is a "nonstatutory" insider of the debtor for the purpose of determining whether the creditor's vote in favor of a nonconsensual chapter 11 plan can be counted. The Court, however, declined in its opinion to rule on the validity of the standard applied by the lower courts to determine nonstatutory insider status and expressly declined to consider whether a noninsider automatically inherits a statutory insider's status when the noninsider acquires the insider's claim.
In Deutsche Bank Trust Company Americas v. Robert R. McCormick Foundation, 138 S. Ct. 1162 (2018), the Court issued an order that, in light of its recent ruling in Merit Management Group LP v. FTI Consulting Inc., the Court would defer consideration of a petition seeking review of a 2016 decision by the U.S. Court of Appeals for the Second Circuit in the Tribune Co. chapter 11 case. In that case, the Second Circuit ruled that the Bankruptcy Code's "safe harbor" shielding certain securities transactions from avoidance as fraudulent transfers preempts creditors' state law constructive fraudulent transfer claims and applies to any transfer that passes through a financial intermediary, regardless of whether the banks and brokers at issue had any beneficial interest in the funds.
In Lamar, Archer & Cofrin, LLP v. Appling, 138 S. Ct. 1752 (2018), the Court ruled that an individual debtor's false statement about a single asset, as distinguished from the debtor's overall financial status, can make a debt for money, property, services, or credit obtained on the basis of the statement nondischargeable in the debtor's bankruptcy case, but only if the statement is in writing.
On October 26, 2018, the Court granted a writ of certiorari in Mission Product Holdings, Inc. v. Tempnology, LLC, No. 17-1657, 2018 WL 2939184 (U.S. Oct. 26, 2018). In granting the petition, the Court agreed to consider whether, under section 365 of the Bankruptcy Code, a debtor-licensor's rejection of a trademark license agreement, which constitutes a breach of such a contract under section 365(g), "terminates rights of the licensee that would survive the licensor's breach under applicable non-bankruptcy law." This question, arising out of a 1988 amendment to the Bankruptcy Code, has recently split the circuits. The Court has scheduled the case for argument on February 20, 2019.
Legislative and Regulatory Developments of 2018
Proposed U.S. Bankruptcy Legislation
The "Small Business Reorganization Act of 2018," S. 3689, H.R. 7190 (introduced on November 29, 2018), would have amended various provisions of the Bankruptcy Code to ease many of the restrictions, limitations, duties, costs, and requirements applicable to small-business debtors; this legislation was introduced in response to the perception that small-business owners are avoiding bankruptcy because of the cost and concerns that they will be forced to sell their companies.
The "U.S. Territorial Relief Act of 2018," S. 3262 (introduced on July 25, 2018), would have given self-governing territories of the U.S. (i.e., Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, and American Samoa) and their instrumentalities the ability to discharge unsecured debts once every seven years, provided that certain financial conditions are met, including prolonged economic downturn and declines in population or natural disasters that cause an unsupportable debt burden that cannot realistically be repaid without imposing undue hardship on the territory's citizens and residents.
The "Student Loan Bankruptcy Act of 2018," H.R. 6588 (introduced on July 26, 2018), would have amended section 523(a)(8) of the Bankruptcy Code to modify the circumstances under which an individual debtor could receive a discharge of certain educational loans and educational benefits received more than five years before the commencement of a bankruptcy case.
The "Medical Debt Tax Relief Act," H.R. 5493 (introduced on April 12, 2018), would have amended the Internal Revenue Code of 1986 to exclude from income any medical debts that are discharged in a bankruptcy case.
The "Providing Responsible Oversight of Trusts to Ensure Compensation and Transparency for Asbestos Victims Act of 2018," S. 2564 (introduced on March 15, 2018), would have amended section 524(g) of the Bankruptcy Code to promote the investigation of fraudulent claims against asbestos trusts established in a bankruptcy case by, among other things, providing penalties for fraudulent claims.
The "Bankruptcy Venue Reform Act of 2018," S. 2282 (introduced on January 8, 2018), would have amended title 28 of the United States Code to, among other things, limit the venue of a bankruptcy filing by a corporate debtor to: (i) the district in which the debtor's principal place of business or principal assets have been located for the 180 days preceding the bankruptcy petition date; or (ii) the district in which a properly venued bankruptcy case of a controlling affiliate of the debtor is pending.
U.S. Treasury Department Report Proposing Chapter 14 of the Bankruptcy Code to Govern Bank Dissolutions
On February 21, 2018, the U.S. Treasury Department issued the Orderly Liquidation Authority and Bankruptcy Reform Report (the "Report") advocating enhancement of the Bankruptcy Code as it applies to financial institutions. The Report is in stark opposition to the Financial CHOICE Act of 2017, which seeks to undo much of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") and fully repeal the orderly liquidation authority (the "OLA") established in Dodd-Frank. Under Dodd-Frank, the Federal Deposit Insurance Corporation is authorized to control the assets of any financial institution the failure of which might disrupt the U.S. financial markets. Opponents of the OLA argue that risky bank behavior is incentivized by providing what amounts to a guarantee fund. The Report, rather than proposing elimination of the OLA, suggests limiting the use of the OLA to only the most distressed cases. The Report also calls for Congress to add a new chapter 14 to the Bankruptcy Code that would allow banks to dissolve without causing a market-wide credit freeze. The text of the Report is available here.
Proposed Amendments to Chapter 15 of the Bankruptcy Code
On August 20, 2018, the National Bankruptcy Conference submitted a letter (the "Letter") to representatives of the House Subcommittee on Regulatory Reform, Commercial and Antitrust Law and the House Committee on the Judiciary that proposed certain technical and substantive amendments to chapter 15 of the Bankruptcy Code. The full text of the Letter is available here. A summary of the proposed amendments is available here.
Amendments to U.S. Bankruptcy Rules
Changes to the Federal Rules of Bankruptcy Procedure (the "Bankruptcy Rules") took effect on December 1, 2018. Most of the amendments apply to the Bankruptcy Rules governing appeals, reflecting corresponding changes to the Federal Rules of Appellate Procedure and the Federal Rules of Civil Procedure. A notable exception is the amendment of Bankruptcy Rule 5005 to require electronic filing of court documents absent good cause on a nationwide basis. In addition, Bankruptcy Rule 8018.1 has been added to allow a district court to treat an appealed bankruptcy court order or judgment as proposed findings of fact and conclusions of law, if the district court concludes that the bankruptcy court lacked constitutional authority to enter the order or judgment. A redline document of the amendments is available here.
Increased U.S. Trustee Fees
Effective January 1, 2018, chapter 11 quarterly fees were increased for the first time in a decade as part of the Bankruptcy Judgeship Act of 2017. The amended fee schedule affects only about the largest 10 percent of chapter 11 debtors, or about 750 cases filed per year. Under the amended fee schedule, debtors who make $1 million or more in quarterly disbursements pay the lesser of 1 percent of disbursements or $250,000. Quarterly fees—along with a portion of filing fees paid by debtors in chapters 7, 11, 12, and 13—are deposited into the U.S. Trustee System Fund to offset appropriations made to the U.S. Trustee Program.
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