Good News for Committees… Standard Carve Out Provisions Do Not Limit Fee Awards

Over and over again the same story plays out.  A case files.  A lender carves-out a small amount from its collateral to fund Committee professionals and an investigation of the lender’s position.  That amount is inadequate, and the Committee blows past the carve-out amount.

That’s just what happened in Molycorp, where the DIP financing agreement contained a typical $250,000 carve-out provision for the Committee’s investigation of claims.

 After an extensive discovery process resulting in asserted claims, mediation, and a global settlement, the court confirmed a consensual plan and the Committee’s counsel requested payment of $8.5 million in fees.

The lender objected, arguing that the $250,000 carve-out was an absolute cap on fee payments.  The Committee responded that while the carve-out may have limited its fees in an administratively insolvent case, it was irrelevant in a case with a confirmed chapter 11 plan.  The Delaware court agreed.

The court explained that “[t]he carve-out is . . . an agreement by the secured creditor to subordinate its liens and claims to certain allowed administrative expenses, permitting such professionals’ fees to come first in terms of payment from the estate’s assets. . . .  [W]hen there are insufficient unencumbered assets to pay professionals’ fees and no plan has been confirmed, professionals’ only recourse is the carve-out.”

Here, however, a plan was confirmed. In that context, Bankruptcy Code section 1129(a)(9)(A) requires that allowed administrative claims be paid in cash (or as otherwise agreed) on the plan’s effective date.  And nothing in the carve-out language suggested that the fee cap would prohibit the allowance of administrative fees upon plan confirmation.

“If the secured parties desire confirmation, the administration claims must be paid in full in cash at confirmation even it if means invading their collateral.”

A World of Caution….

 The court contrasted the carve-out at issue with one in a DIP financing order entered in another case that stated: “[n]otwithstanding anything to the contrary therein, and absent further Order of the Court, (i) in no event during the course of the Chapter 11 Cases will actual payments in respect of the aggregate fees and expenses of all professional persons retained pursuant to an Order of the Court by the Creditor’s Committee exceed $450,000 in the aggregate (the ‘Creditors’ Committee Expense Cap’) … (iii) any and all claims (A) incurred by the Creditor’s Committee in excess of the Creditor’s Committee Expense Cap or (B) incurred by any professional persons or any party on account of professional fees and expenses that exceed the applicable amounts set forth in the Budget shall not constitute an allowed administrative expense claim for purposes of section 1129(a)(9)(A) of the Bankruptcy Code.”  At the same time, the court offered “no opinion as to whether it would approve a DIP order containing [such] provisions” had it been presented ….

See In re Molycorp, Inc., 562 B.R. 67 (Bankr. D. Del. 2017).

 

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Tequila Shots, Default Interest, and the 9th Circuit’s Reversal of In re Entz-White

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Friday night I hosted a Día de los Muertos party.  Naturally, I invited other bankruptcy attorneys. And when you mix lawyers and tequila, things can get pretty crazy.  It wasn’t long before someone was well into an animated story about his Absolutely Worst Day Ever as a Lawyer. Now that its Monday morning and we’ve all sobered up, here’s a recap of his Very Bad Day and the surprise reversal of In re Entz-White that caused it.

Last Week, Debtors Could Avoid Accrued Post-Default Interest in the 9th Circuit by Curing an Underlying Default…

My friend (let’s call him “Roberto”) was representing a debtor that had fallen behind on its loan and was facing insurmountable default interest.  If it could avoid the default interest and other late penalties, it could otherwise cure its defaults, restore its loan to its original terms, and successfully reorganize. “No problem!” Roberto had said. And he took the case on a contingency.

Roberto was right. In re Entz-White Lumber & Supply, Inc., decided back in 1988, held that when a debtor cures a default it may avoid all consequences of the default, including higher post-default interest rates. In other words, it may both repay arrearages at the lower, pre-default interest rate and return to pre-default conditions, including pre-default interest rates, for the remainder of the loan obligation.

Mechanically, it works like this. Section 1123(a)(5)(G) of the Bankruptcy Code requires that a debtor’s plan of reorganization adequately provide for its implementation, including by “curing” any default.  The Bankruptcy Code contains a long list of definitions. Oddly, “cure,” used throughout the Bankruptcy Code, is not one of them. To fill in that gap, the Ninth Circuit adopted the Second Circuit’s definition of cure, e.g., curing a default means taking care of the triggering event, thereby nullifying all of its consequences, including default penalties such as higher interest.

Roberto had relied on Entz-White in charting a path forward for his client. The case was on the verge of confirmation, and he was on the verge of earning his contingency fee.

…. But on Friday, the 9th Circuit Issued a New Opinion Overturning Its Prior Ruling

On Friday, instead of celebrating, Roberto was shooting tequila in my living room and crying into his cerveza.

In In re New Investments, decided earlier that day, the Ninth Circuit overturned its opinion in Entz-White, holding that Bankruptcy Code Section 1123(d) voided Entz-White’s rule that a debtor who proposes to cure a default may avoid a higher, post-default interest rate in the loan agreement.  The Ninth Circuit reversed the bankruptcy court’s underlying order, which had confirmed a Chapter 11 plan based on Entz-White… and simultaneously upended my friend’s pending case as well.

Section 1123(d), which was enacted in 1994, well after Entz-White was decided, states that:

Notwithstanding subsection (a) of this section and sections 506(b), 1129(a)(7), and 1129(b) of this title, if it is proposed in a plan to cure a default the amount necessary to cure the default shall be determined in accordance with the underlying agreement and applicable nonbankruptcy law.

Following is a brief summary of the case and the court’s rationale.

1. Evaluating Applicable (Washington State) Nonbankruptcy Law

In New Investments, the debtor had defaulted on a real estate loan, thereby triggering a default-interest provision. It then filed for bankruptcy protection to avoid foreclosure.  Its plan was to sell its property and then use the sale proceeds to payoff the loan – thus curing the default – at  the pre-default interest rate. The lender objected, pointing to its contractual rights under a promissory note that called for payment of a higher interest rate (equating to approx. $670,000) upon default. The loan agreement was governed by Washington state law. The Ninth Circuit concluded that Washington allows for a higher interest rate upon default when provided for in the loan agreement. See Wash. Rev. Code Ann. Section 61.24.090(1)(a). Thus, it held that cure, as determined under the parties’ contract and applicable state law, required payment of accrued default interest.

2. The Plain Language of Section 1123(d) Drives the Ninth Circuit’s Decision

The Ninth Circuit stated that the plain language of Section 1123(d) compelled its decision. As with all plain-language arguments, there is nothing to analyze here. You can read Section 1123(d) and decide for yourself whether you agree.

3. Surprise! The Legislative History Indicates This Result May Be Unexpected

In case you disagree with the Court’s plain reading of the statute, the Ninth Circuit also looked to the statute’s legislative history and stated it would not help New Investments. Essentially, the Ninth Circuit concluded that Congress had a very particular, and different, purpose in mind when it enacted Section 1123(d) and that it may not have anticipated all of the statute’s consequences. But that, it said, is not a good enough reason to ignore the statute’s plain meaning.

What was Congress trying to do when it enacted Section 1123(d)? The legislative history indicates Congress was primarily concerned with overruling the Supreme Court’s decision in Rake v. Wade, which had stated that, in order to cure a default, a Chapter 13 debtor would have to pay interest on his arrearages even if the underlying loan agreement did not provide for it. Congress was concerned that Rake v. Wade provided an unbargained-for windfall for creditors and enacted Section 1123(d) to “limit the secured creditor to the benefit of the initial bargain.” Congress, the Ninth Circuit acknowledged, may not have anticipated how Section 1123(d) would be interpreted in other contexts.

But the Ninth Circuit felt that its holding, if unanticipated, would not be inconsistent with Congressional intent. In holding the secured creditor to the benefit of its bargain, Congress had said that a cure pursuant to a plan should “put the debtor in the same position as if the default had never occurred.” That, it said, is consistent with holding both parties to the benefit of their bargain and with the concept of cure generally (which it conceeded Section 1123(d) did not alter or attempt to define).

The Ninth Circuit tacitly recognized that its holding will make it more difficult for some debtors to reorganize, undermining the Bankruptcy Code’s goals of offering a fresh start to honest debtors. But it felt that its decision strikes an appropriate balance between the interest of debtors and creditors.

4. The Interpretation of Cure in Section 1123 is Consistent With the Concept of Unimpairment

The Ninth Circuit also stated that its ruling in New Investments would be consistent with the concept of unimpairment under the Bankruptcy Code.  To render a creditor “unimpaired” such that it cannot object to a debtor’s plan, the debtor must cure defaults and may not “otherwise alter the legal, equitable, or contractual rights” of the creditor. One of these rights is post-default interest.

Future Default Interest Differentiated

It is worth noting that the New Investments decision focuses on the treatment of accrued, default interest when a debtor is calculating required cure amounts.  But once default interest or other penalties are paid and a default is therefore cured, the debtor can still return to pre-default conditions as to the remainder of the loan obligation.

Judge Berzon’s Dissenting Opinion

In a dissenting opinion, Judge Marsha S. Berzon wrote that neither Section 1123(d) nor any other provision of the Bankruptcy Code provides a definition of “cure” contrary to the one announced in Entz-White.

As for the majority’s conclusion that Congress displaced Entz-White when it passed Section 1123(d)? Judge Berzon argues at length that this conclusion is not supported by either the plain language of the statute or its legislative history. Instead, Judge Berzon argues that the Court should not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure.

My friend Roberto would certainly agree.

Download the Case Here

Pacifica L 51, LC v. New Investments Inc. (In re New Investments, Inc.) No. 13 -36194 (9th Cir.) 2016.

 

 

 

SCOTUS Sets Oral Argument in Jevic For Nov. 28, 20016

For those of you watching for a ruling from the Supreme Court in In re Jevic, mark your calendars! Oral argument has been set for Monday, November 28, 2016.

44303734_l.jpgIf you haven’t been tracking the case, this is an excellent time to get up to speed.

Simply put, the Supreme Court granted certiorari in Czyzewski v. Jevic Holding Corp. to decide whether “structured dismissals” can be used to wrap up a Chapter 11 bankruptcy case.  A structured dismissal is a creative (or, depending on your perspective, inappropriate) solution that bankruptcy lawyers have come developed to resolve a case–often following a sale of substantially all of the company’s assets–without the delay and expense of a formal chapter 11 plan process but with more elegance and closure than creditors would have if the case were simply dismissed. The problem? Nothing in the Bankruptcy Code contemplates “structured dismissals.” And often they include “gifting” of assets from a secured creditor’s collateral to various unsecured creditors. Unhappy creditors who are left empty-handed have complained that these agreements violate the priority of creditor distributions called for under Section 507 of the Bankruptcy Code.

For a more detailed discussion, you might want to read Rochelle’s Daily Wire, published by the American Bankruptcy Institute.  Or if you want to go really crazy, you can read all the pleadings on the Supreme Court’s blog.

Mette H. Kurth