Tired of Election Tweets? Follow the Delaware Bankruptcy Court Instead.

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The Delaware Bankruptcy Court is now on Twitter.  Follow the Court and receive updates @USCourtsDEB.

No political tweet-storms here. Instead, find out how you, too, can comment on the local rules this fall. Better yet, peruse the local rules in Word or PDF format. Be the first to receive exciting tweets about bankruptcy procedure and rules in the months to come.

Mette H. Kurth

When is a Settlement Not a Settlement? When It Is an Asset Sale.

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For business people, whether you are settling a dispute or selling an asset may seem obvious. But for lawyers, the distinction can be surprisingly tricky, and it has serious ramification for our clients.

The confusion arises because the Bankruptcy Code allows you to either sell or settle a claim that a debtor has against someone else. What happens if the trustee settles a claim against a defendant in exchange for a cash payment, and a creditor objects because it believes the claim is worth more than is being paid? What if a trustee wants to sell claims that the debtor has against third parties? Whether these transactions are treated as settlements or sales matters quite a bit.

When selling an asset under Bankruptcy Code section 363, you must demonstrate that you have maximized the asset’s value. To settle a claim, the bar is much lower. Bankruptcy Rule 9019 requires that you show that the settlement is fair and equitable, which generally means that it does not fall below the “lowest point in the range of reasonableness.” Moreover, you cannot appeal a bankruptcy sale to a good faith purchaser unless you obtain a stay. (This is meant to encourage bidding in bankruptcy sales by protecting good faith purchasers). A settlement, in contrast, can be appealed without a stay.

The Ninth Circuit Court of Appeals recently adopted the BAP’s earlier reasoning in Mickey Thompson (decided in 2003) and the reasoning of the Fifth and Third Circuits, holding that a bankruptcy court has the discretion to apply the more stringent standards and procedures for sales to a settlement agreement in order to maximize value.

In Adeli v. Barclay, the bankruptcy trustee had entered into a settlement agreement with a creditor under which the creditor would purchase the estate’s claims against it in exchange for both cash and a waiver of the creditor’s claims against the estate. The trustee filed a motion to approve the settlement under Rule 9019 and presented evidence regarding the settlement’s reasonableness. It also noticed the matter as a sale subject to overbidding under Section 363. Nobody submitted an overbid. The debtor then appealed the settlement to the district court—but without seeking a stay pending appeal. The Ninth Circuit concluded that, because the bankruptcy court determined that the creditor/buyer was a good faith purchaser of the potential claims, and the debtor did not seek a stay pending appeal, the appeal was moot under Bankruptcy Code section 363(m) and was properly dismissed.

While the Ninth Circuit’s decision adopted Mickey Thompson’s reasoning and does not appear to significantly change current practice, it does serve as a stark reminder of the very real differences between sale and settlement procedures. Meanwhile, its time for the lawyers to update their form files to replace references to Mickey Thompson with a citation to Adeli v. Barclay.

Adeli v. Barclay (In re Berkeley Delaware Court, LLC), No. 14-55854 *10 (9th Cir. August 23, 2016). Download in PDF

Mette H. Kurth

How to Appoint a Trustee. Be Clear. And Be Convincing.

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 A recurring theme—one that enrages creditors—is that of a business owner who secretly transfers assets from a failing business to friendly affiliates and then files bankruptcy, leaving creditors holding the bag.

The Bankruptcy Code tries to address this by requiring that debtors open their books to the court and creditors. Where there is fraud or dishonesty, a creditor can ask the Court to appoint a trustee.  Procedurally, however, debtors have a home court advantage.

The following case illustrates just how hard it can be… and the importance of creating a strong evidentiary record, including expert testimony, even if you think you’ve caught the debtor red handed.

“Vehemence,” the court said, “is no substitute for evidence.”

What Happened Was….

Pedro Lopez-Munoz owned and operated gas stations in Puerto Rico, both individually and through a corporation that he owned. When the business fell on hard times, he sold his interests in the gas stations to his corporation and then transferred ownership of the corporation to a trust. And guess what? Pedro was the trust’s principal beneficiary.

Seven months later, Pedro filed a Chapter 11 bankruptcy case. He didn’t mention his financial interests in the gas stations.  Although he did disclose that he had transferred ownership of the gas stations to his trust, the statements he made were incomplete and misleading. Significantly, he claimed (incorrectly) that the trust beneficiaries were his children, not himself.

One of Pedro’s creditors learned about the transfers through legal discovery. It responded by asserting that Pedro had been trying to defraud his creditors, and it sought appointment of a Chapter 11 trustee.  The U.S. Trustee’s Office supported the motion. That’s important because the U.S. Trustee’s Office serves as a watchdog for bankruptcy fraud. Having their support can send a strong signal that there are real issues.

In response, Pedro rescinded the transfers and corrected his disclosures.  As for why he made the transfers?  Pedro said he was really just trying to help all of his creditors out by shielding his assets from one particularly aggressive creditor. He also submitted expert testimony from his CPA stating that the transfers had no material effect on his bankruptcy estate because all proceeds were paid over to his secured creditors.

What Did the Court Do?

The appointment of a trustee is an extraordinary act, and the moving party (i.e., the creditor) has the burden of proving the appointment is justified. This is the debtor’s home court advantage.

After a two day hearing, the Bankruptcy Court said that the bonding company had not proven that a trustee should be appointed.  The bonding company disagreed, appealed, and lost.  Why?

The appellate court believed that Pedro’s explanation for the transfers (e.g., I was trying to help my creditors!) was credible enough to overcome a presumption of fraud.

Surprised?  So was I at first.  But the appellate court pointed out that the bonding company didn’t get an expert squarely in front of the trial court. Pedro’s expert, on the other hand, testified that there was no fraud and the transfers didn’t harm creditors. Since Pedro’s expert was largely unchallenged, Pedro won.

The Legal Underpinnings

 Here’s a closer look at the court’s reasoning.  The case was heard by the Bankruptcy Appellate Court in the First Circuit.  Bankruptcy Code section 1104(a)(1) states that if a creditor requests appointment of a trustee, the court shall approve the request:

  • For cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case . . . ; or
  • If such appointment is in the interests of creditors, any equity security holders, and other interests of the estate . . . .

The appellate courts agree that there is a strong presumption against appointing a trustee.  However, they don’t agree about what a creditor must do to overcome this presumption.  Most state that the creditor must present “clear and convincing evidence.”  Some are satisfied with a preponderance of evidence.  The First Circuit hasn’t yet decided which standard to apply.

Both the bankruptcy and appellate courts hedged their answer on this issue.  On one hand, the bankruptcy court decided that the majority’s approach (“clear and convincing evidence”) was correct.  On the other hand, it stated that the standard to be applied didn’t matter because, under Puerto Rico’s fraud statute, a trustee wasn’t justified under either standard.  The Bankruptcy Appellate Court—remarking on the lack of expert testimony to support the creditor’s motion—agreed.  It held that, under either standard, the creditor had not shown a benefit to appointing a trustee that would outweigh its cost.

So Pedro avoided a trustee and it seems that the First Circuit could be falling into line with the majority rule, requiring clear and convincing evidence to justify appointment of a trustee.

United Surety & Indemnity Co. v. Pedro Lopez-Munoz (In Re Pedro Lopez-Munoz), 1st Cir. BAP No. PR16-011, Bankr. Case No. 13-08171-EAG (July 28, 2016).

View the Opinion in PDF

Mette H. Kurth

About Bankruptcy. Beer. And Blogging.

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Welcome to The Bottom Line!  A Business Bankruptcy Blog.  In Plain English.

There are few things that can clear a room faster than telling someone you are a lawyer.  Except perhaps telling them you are a bankruptcy lawyer.

I have always rejected the idea of inflicting yet another IRAC-ridden blog full of legalease and case cites onto the world.  (IRAC?  Huh?  IRAC, Issue-Rule-Analysis-Conclusion, is the formulaic rule for legal writing inflicted on first-year law students to force them to think like lawyers. IRAC is one of many things that makes legal writing, and lawyers, boring.)

Then I remembered my father and his fuzzy eggbeaters.  Few classes fill up more slowly than an 8:00 a.m. economics course.  (Or a bankruptcy class.)  But my father, a professor of economics, always had wait lists for his classes. They were popular. He did not talk about widgets.  His hypothetical businesses manufactured fuzzy eggbeaters.  His beer and pizza graphs illustrating diminishing marginal utility were famous (among economics majors).  At Halloween, he gave extra credit for the best economics-themed costumes. One very pregnant co-ed won by drawing an expectations curve on her t-shirt.  He hosted backyard barbecues for his students.  Although I wouldn’t admit it then, my dad was sort of cool.

Unfortunately, I can’t invite all of you to my house for a beer and burgers while we discuss fascinating issues of finance and bankruptcy law.  Keeping you entertained may not be easy.  But it is my pledge to you to be clear.  To be relevant.  And as much possible, not to be boring.

Cheers!

Welcome to The Bottom Line!

Mette H. Kurth