In Nortel Networks, Inc., Case No. 09-0138(KG), Doc. No. 18001 (March 8, 2017), the Delaware Bankruptcy Court ruled on the objections of two noteholders who asked the Court to disallow more than $4.4 million of the $8.1 million of the fees sought by counsel to their indenture trustee.  Given the detailed rulings announced by the Court, the decision may establish a number of guidelines by which future fee requests made by an indenture trustee’s professionals will be measured.

Matters Handled by the UCC

The noteholders’ objection asserted that the trustee had breached its fiduciary duties because it had permitted its counsel to rack up millions of dollars of unnecessary fees during litigation that was being adequately handled by the Unsecured Creditors Committee (UCC). As proof, the noteholders pointed to the fact that the litigation was ultimately settled by counsel to the UCC pursuant to a global settlement which resulted in a resolution of the entire bankruptcy case.  In response, the Court noted that the trustee’s fiduciary duties with respect to the direction of counsel are governed by the “prudent person” standard, but that that standard cannot be applied through the 20/20 lens of hindsight.  Instead, the trustee’s actions must be analyzed in the context of the facts known at the time of the direction.

The Court observed that Nortel was an unusually long, complex and contentious proceeding in which the trustee and its counsel were required to protect the noteholders’ rights during a number of hotly contested proceedings, any one of which might have significantly and adversely affected the noteholders’ recoveries.  Thus, during the case, it would not have been prudent for the trustee to rely solely upon counsel to the UCC to protect the interests of the noteholders.  The fact that the case was ultimately resolved by the efforts of the UCC was not dispositive since, at the time, the trustee could not have prudently assumed that result.  The Court did, however, contrast the litigation issues which might have directly affected noteholders with matters, e.g., attendance at regular meetings of the UCC, which only affected general unsecured creditors as a whole.  Those latter issues were in fact being adequately handled by counsel to the UCC, and fees for more than one counsel representing the trustee at regular meetings of the UCC would be disallowed.

Transition Fees

The noteholders objected to fees charged by the trustee’s predecessor counsel for time spent transitioning the representation to the trustee’s current counsel. The Court found, as an evidentiary matter, that predecessor counsel had been uncooperative during the transition process, thereby necessitating more work by successor trustee counsel.  Accordingly, it sustained the noteholders’ objection based upon predecessor counsel’s “nonfeasance.”

Fees for Defending Fees

The noteholders objected to fees incurred by the trustee in defending the fee objection, citing the U.S. Supreme Court’s recent ASARCO case which stands for the proposition that lawyers cannot recover fees for defending their own fees in a bankruptcy proceeding.  The Bankruptcy Court noted, however, that ASARCO allowed an exception where one party had contractually agreed to pay the fees of the other party.  The Bankruptcy Court ruled that the indenture was such a contract because it required the debtor to pay the fees of trustee’s counsel and, in any event, granted the trustee a charging lien on any recovery owed to the noteholders.

All told, of the $8.1 million in asserted fees, the Bankruptcy Court sustained the noteholder’s objections to the extent of $913,936.70. The Court specifically remarked that it was generally unsympathetic to the noteholders’ complaints in light of the fact that the noteholders had never objected to counsels’ fees until near the end of the case.

In general, Nortel is a favorable decision for indenture trustees and their counsel, which stands for the proposition that fees should not be second-guessed with hindsight so long as there is a reasonable need to protect the specific interests of the noteholders.

One of the most powerful and oft used devices in bankruptcy is the sale of assets “free and clear” of liens, claims and interests. One issue a buyer at a bankruptcy sale must consider, however, is whether due process has been met with respect to parties whose liens, claims and/or interests are released through such sale.  Indeed, a lack of due process could foil a “free and clear” sale, leaving a buyer with an encumbered purchase and nowhere to turn for recourse.

In In re Olsen, a Wisconsin bankruptcy court considered whether the failure to provide formal notice to a party with a right of first refusal (ROFR) on certain of the debtor’s real estate (Property) voided the court’s “free and clear” sale order. The court held that the sale process did violate due process and that the effective remedy was honoring the ROFR in a subsequent (post bankruptcy) sale of the Property.

In order to maximize the going concern value of its grain facility business, the debtor sought to sell substantially all of its assets in conjunction with its plan of reorganization. Archer-Daniels-Midland (Purchaser) purchased the assets, including the Property.  Subsequent to the conclusion of the bankruptcy case, the Purchaser sold the Property to a third party.  Country Visions Cooperative (Objector), the holder of the ROFR, sued the Purchaser in state court and asserted its ROFR.  The Purchaser countered by moving to reopen the bankruptcy case to enforce the confirmation order and bar the Objector’s state court proceeding.

In upholding the ROFR, the bankruptcy court found three important undisputed facts: (i) the Objector was not listed as a creditor of the debtor, and did not receive formal notice of the bankruptcy case, (ii) the Objector never received formal notice that the Property was to be sold free and clear of the ROFR, and (iii) the Objector never received the contractual notice that the Property was being sold as required by the ROFR.

Notably, the Objector did receive informal notice of the bankruptcy case and may have even learned about the sale shortly before closing. However, such notice was not “notice reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections”—as due process requires.  Thus, the bankruptcy court concluded that the Objector did not receive sufficient notice before its ROFR was purportedly extinguished.

The Purchaser argued that notwithstanding the faulty notice, the court should enforce the confirmation order to strip the ROFR because the Purchaser was a bona fide purchaser that acquired the Property in good faith under section 363(m) of the Bankruptcy Code. The court rejected this argument, explaining that a bona fide purchaser cannot have notice of a prior adverse claim.

Here, the Purchaser did have prior notice of the ROFR (even if the notice was constructive) because the ROFR was properly recorded. The Purchaser also had received an email indicating that someone had a ROFR on the Property.  The court explained that the Purchaser easily could have commissioned a title report and ensured that all parties in interest received due notice.   The court acknowledged that the debtor should have properly noticed all parties in interest, including the Objector, but also found that the Purchaser could not “cloak itself with the mantle of a bona fide purchaser when it ignored information suggesting the [Objector’s] rights were not addressed in the sale.”  Thus, the court approved the Objector’s request to enforce its ROFR in the Purchaser’s post-bankruptcy sale of the Property.

In sum, a buyer in bankruptcy should consider independently ensuring that all parties with purported liens, claims or interests in the sale assets receive proper notice of the sale; hoping that the debtor provides proper notice may not be sufficient.  A little effort up front can save time, money and aggravation in the end.

There are numerous reasons why a company might use more than one entity for its operations or organization: to silo liabilities, for tax advantages, to accommodate a lender, or for general organizational purposes. Simply forming a separate entity, however, is not enough. Corporate formalities must be followed or a court could effectively collapse the separate entities into one. A recent opinion by the United States Bankruptcy Court for the District of Massachusetts, Lassman v. Cameron Construction LLC provides a cautionary tale for companies that ignore critical guidelines necessary to maintain separateness.

Substantive consolidation is an equitable remedy in bankruptcy that has the effect of consolidating the assets and liabilities of separate entities into a single entity. Substantive consolidation is a highly unpredictable area of law; courts have developed no fewer than five different tests. While the cases are inherently fact-specific, common factors have emerged to provide some guidance.

In Cameron Construction & Roofing Co., the debtor operated a roofing company. Its primary assets at the time of its Chapter 7 bankruptcy were vehicles and tools, which were not sufficient to pay its creditors. Twelve years before the bankruptcy, the debtor’s majority owner formed a separate limited liability company (“LLC”) to own the real estate where the debtor operated its business, a common and reasonable strategy considering the environmental concerns with the property. The debtor and LLC maintained some corporate formalities, including filing separate tax returns and annual statements, and issuing separate W-2 statements for employees.

Nevertheless, over time, the role of the LLC evolved into more than a simple real estate holding company. It leased the property to the debtor at above-market rates and employed and paid the salaries of workers that performed services exclusively for the debtor (allegedly to avoid the debtor paying higher workers’ compensation premiums). Neither the debtor nor the LLC documented their intercompany transactions. Moreover, the debtor and the LLC apparently did not provide any notice of their separateness to their respective creditors.

Ultimately, the court found consolidation of the debtor and the LLC (a non-debtor) to be appropriate. Key to the court’s decision was a finding that there was a “substantial identity” between the debtor and the LLC. The court highlighted several of the more common substantive consolidation factors: common ownership of the debtor and the LLC, a lack of corporate formalities, and the absence of formal agreements between the entities (of note, even if there had been a formal lease between the debtor and the LLC, the above-market rent would have been problematic since agreements between entities should be similar to those available on an arms-length basis with unaffiliated third parties). The court also considered the benefit and harm to creditors resulting from consolidation, finding that no creditor of the LLC would be harmed by consolidation while creditors of the estate would benefit.

There are dozens of steps that companies can take to maintain proper separateness, signal to their creditors that only a particular entity’s assets are available to satisfy its liabilities, and decrease the likelihood that a court disregards a chosen corporate structure. The debtor in Cameron Construction & Roofing Co. and its related LLC took some of these steps, but ignored many others. These steps must be followed as much as possible or else companies operating related entities may unwittingly fall into the substantive consolidation trap.

In a recent decision (“Energy Future Holdings”) poised to have wide-reaching implications, the Third Circuit Court of Appeals reversed the decisions of the Bankruptcy and the District Courts to hold that a debtor cannot use a voluntary Chapter 11 bankruptcy filing to escape liability for a “make-whole” premium if express contractual language requires such payment when the borrower makes an optional redemption prior to a date certain. In so doing, the Third Circuit expressly rejected the reasoning of the Southern District of New York in the Momentive decisions, which reviewed similar language and held that no “make-whole” was due. The Momentive decisions are under advisement by the Second Circuit Court of Appeals, setting the stage for a potential circuit split.

In Energy Future Holdings, the debtor (“EFIH”) filed for bankruptcy for the explicit purpose of refinancing the debt at favorable interest rates (saving over $13 million per month) and avoiding its obligation to pay the make-whole premiums to both its first and second lien noteholders.  Several weeks after the bankruptcy filing, EFIH executed this strategy and the noteholders objected.  Both lower courts approved of EFIH’s actions, finding that the section of the indenture that accelerated the debt upon bankruptcy did not mention the make-whole payment, therefore none was due.

The Third Circuit took a different view of the two relevant provisions in the indentures: Section 3.07, which provided that at any time before December 1, 2015 the notes could be redeemed for 100% of the principal amount plus, inter alia, the make whole payment, and Section 6.02, which provided that upon a bankruptcy filing, all outstanding notes are due and payable immediately.

The Third Circuit found that these two provisions are not at odds with each other, and that New York law requires that that both provisions be given effect. The concept of “redemption” (as opposed to prepayment), under both New York and federal law, is not limited to only repayments of debt that predate its maturity; rather, redemption includes both pre-and post-maturity repayments of debt.  The redemption by EFIH was optional, despite the automatic acceleration of the debt under Section 6.02, as (i) EFIH voluntarily filed for bankruptcy, (ii) EFIH could have reinstated the accelerated notes’ original maturity date, and (iii) EFIH redeemed the notes over the noteholders’ objections.  To the Third Circuit, after reviewing the relevant indentures and the facts of the payments, “Redemptions, not prepayments, occurred here, they were at the election of EFIH, and they occurred before the respective dates [in the indentures].”

It remains to be seen whether the Second Circuit will agree with the analysis of the Third Circuit concerning almost identical operative sections of the respective indenture agreements, or whether it will uphold the lower courts’ decisions in Momentive. Under the Third Circuit’s holding, however, borrowers in that jurisdiction seeking the ability to avoid payment of the make whole upon acceleration of the debt need to make that expressly clear in the governing contract.

A recent opinion issued by the United States District Court for the Northern District of Illinois reminds us that corporate veil-piercing liability is not exclusive to shareholders. Anyone who is in control of and misuses the corporate structure can be found liable for the obligations of the corporation.  The facts of this case, however, did not support personal liability for veil-piecing.

In Seamans v. Hoffman, et al., the court was asked to find a former owner (Tauriac) of a debt collection agency personally liable for a violation of the Fair Debt Collection Practice Act (FDCPA).  Tauriac had recently sold the business but remained in control of the business bank account in order to reconcile and appropriately allocate between the pre- and post-sale receivables—the pre-sale receivables were owed to Tauriac per the terms of the sale transaction.

During this reconciliation period, the company attempted to collect a debt from an individual who had gone through a bankruptcy proceeding in which the debt was discharged. The individual, alleging violations of the FDCPA, sued and obtained a default judgment against the company and Tauriac.  Tauriac got the default judgment overturned and pursued the merits of her defense.

As an initial matter, the court recognized that under normal circumstances, “officers and shareholders of a debt collection [company] generally cannot be held liable for violations of the FDCPA.” An exception exists, however, if there is a basis to pierce the corporate veil.  Thus, if an individual exerts sufficient control and dominance over the entity and misuses the corporate structure, personal liability may be found.

Here, apart from the control Tauriac had over the business bank account pursuant to the terms of the sale agreement, she did not exhibit any other indicia of control or dominance over the corporation: she did not manage employees, she did not manage collection efforts, she did not interact, post-sale, with the company (other than with respect to the bank account), there was no evidence that she comingled her assets with those of the company, or otherwise used corporate assets to pay her expenses. In short, she did not disregard the corporate entity to use it as a mere instrumentality for personal gain.  Absent these indicia of control or evidence of personal use, there can be no personal liability for corporate obligations under a veil-piercing theory.

The take-away from this case is that there could be situations where a non-shareholder is held liable under a veil-piercing theory, if control, dominance and misuse are present.

In an earlier blog piece we reported on the Third Circuit’s 2015 decision in In re Jevic Holding Corp. where the Court approved a settlement, implemented through a structured dismissal, which allowed junior creditors to receive a distribution prior to senior creditors being paid in full.  The decision was appealed and the Supreme Court agreed to hear the case and decide whether structured dismissals are permissible in bankruptcy.  More to come…

By LEN WEISER-VARON and BILL KANNEL

Today’s U.S. Supreme Court decision in Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust puts an end to one of Puerto Rico’s multi-pronged efforts to deleverage itself.  Given the comprehensiveness of the First Circuit’s intermediate appellate opinion upholding the district court’s invalidation of Puerto Rico’s Recovery Act, it was surprising that the highest court took the case, a decision apparently prompted by Justice Sotomayor’s interest in obtaining a reversal.  Comments of some other Justices at oral arguments raised the possibility of Sotomayor attracting a majority for the proposition that the preemption provisions of Section 903 of the U.S. Bankruptcy Code were inapplicable to Puerto Rico, but in the end only Justice Ginsburg joined what turned out to be Sotomayor’s dissenting opinion in a 5-2 ruling upholding the relegation of the Recovery Act to the dustbins of history.

As  we have written previously, the Recovery Act was damaged goods from the beginning: even if the fairly clear preemption argument had not prevailed, the Contracts Clause constraints on non-federal bankruptcy legislation would have severely constrained, if not eliminated, the effective use of  the Recovery Act to break bond contracts. In any event, the Recovery Act, and the Supreme Court’s decision, were  a couple weeks away from being moot, as it appears evident that Congress will pass PROMESA, the federal oversight and debt restructuring legislation that has always constituted the logical legal mechanism for those favoring a less chaotic denouement to Puerto Rico’s debt woes.

BY STEPHEN M. WEINER

Price disparities among hospitals pose one of the more intractable issues for policy makers, regulators and the government. That they exist is indisputable. Why they exist is a source of much contention.  And the issue creates great disunity within the hospital world, causing fissures especially between academic medical centers and community hospitals.

Continue Reading Tackling the Dragon of Hospital Price Disparity: Massachusetts’s On-Going Efforts to Address Price Equity

Shareholders who received nearly $8 billion from the Tribune Company leveraged buyout (LBO) do not have to give back that money as a constructive fraudulent transfer. Although the possibility remains that the creditors can recover this money through the pending intentional fraudulent transfer claims, which are much more difficult to prove, the Second Circuit recently held that the Bankruptcy Code preempts creditors from recovering under state constructive fraud theories when shareholders receive distributions under securities contracts effectuated through financial institutions.

Continue Reading TRANQUIL WATERS ONCE AGAIN IN THE SAFE HARBOR: Bankruptcy Safe Harbor Protects Shareholders From State Constructive Fraud Claims

A recent bankruptcy court decision from the influential Southern District of New York permitted a debtor to reject executory contracts with midstream gathers as an exercise of sound business judgment. In In re Sabine Oil & Gas Corporation, the court issued an advisory ruling in which it determined that certain provisions of the rejected contracts were not covenants that ran with the land, and thus could be rejected thereby relieving the debtor of a financial hardship.

Continue Reading Oil, Gas and Mineral Companies Take Note: Agreements Purporting to “Run with the Land” may be Rejected in Bankruptcy