,

Insolvency Law Committee

UPDATE: At midnight on March 27, 2022, certain provisions of the CARES Act expired. Importantly for insolvency practitioners, the subchapter V debt limit of $7,500,000 reverted to the lower original amount of $2,725,625. It appears that Congress is working to reinstate the higher debt limit and at least one bill has been proposed (S. 3823) and passed by the Senate on April 8, 2022, reinstating the $7,500,000 debt limit and adding language to make it effective retroactively, but with a two year expiration date. However, the status of this bill or any other efforts by Congress to increase the subchapter V debt limit remains unclear.

 

 

April 20, 2022

Dear constituency list members of the Insolvency Law Committee:

The following is a case update written by Wendy W. Smith, a partner in Binder & Malter, LLP, analyzing a recent decision of interest:

SUMMARY
On December 16, 2021, Judge Colleen McMahon of the United States District Court, Southern District of New York, vacated the order confirming Purdue Pharma’s Chapter 11 plan of re-organization, holding that the bankruptcy court had no power to impose a non-consensual release by third parties of their direct claims against non-debtors. In re Purdue Pharma, L.P., 2021 WL 242236 (S.D.N.Y 2021). The non-debtors here included all of the Sackler family, owners of Purdue Pharma, who were to be released from virtually all non-criminal claims related to the companies and their primary product–OxyContin. In exchange for that release and the related injunctions (the “Shareholders Release”), the Sackers were to pay over $4.275 billion into the plan of reorganization.

To view the opinion, click here.

On first review, the opinion might appear as having limited impact outside the Second Circuit. But many of Judge McMahon’s arguments can apply to any situation where a bankruptcy court exercises authority that is not specifically described in the Bankruptcy Code, particularly to enjoin third parties from suing non-debtors.

FACTUAL BACKGROUND
The Sackler Family’s Role in Purdue Pharma and the OxyContin Litigation.

From the opening of her opinion, Judge McMahon reveals her sensitivity to the underlying issue driving the case—the catastrophic impact of the opioid crisis in America—and that her ruling will most likely result in undoing the Sackler’s funding of the proposed plan and its programs to address opioid addiction. (p. 137) Although the opinion rules only on matters of law, as no finding of fact was appealed, Judge McMahon repeatedly returns to the extreme circumstances of the case to color her legal analysis.

To provide that context, Judge McMahon devotes the first half of the opinion to the facts. She begins with the history of Purdue Pharma and its development and marketing of OxyContin, which has been blamed in large part for fueling the opioid crisis. Judge McMahon describes that before Purdue’s bankruptcy, OxyContin accounted for more than 90% of the company’s U.S. revenue. The Sackler family, which owns the companies, is described as being “long ranked on Forbes’ List of America’s Richest Families,” with a reported net worth in 2015 of $14 billion. (p.11) Judge McMahon states that the Sackler family controlled the operation of the Purdue companies until just before the bankruptcy filing.

The core of Judge McMahon’s factual description is Purdue’s aggressive, and allegedly deceptive, marketing of OxyContin for over 20 years and the resulting litigation with both governments and individuals. Most of the litigation claimed in part that Purdue’s actions caused the over-prescription of OxyContin, leading to addiction, which then resulted in addicted patients turning to street drugs when prescriptions were no longer available.

In 2007 Purdue settled litigation with 26 states, agreeing to pay $19 million and to implement an extensive program to limit OxyContin abuse. (p.21). Purdue was not required to stop the production or sale of OxyContin, however, which it continued. Litigation also continued. When the resulting discovery revealed that individual members of the Sackler family were involved with Purdue’s OxyContin marketing efforts, those individuals were added to the actions. [1]

After the 2007 settlement agreement, the Sacklers began taking substantially greater distributions of revenue from Purdue, which “substantively depleted Purdue’s treasury.” (p.37) Judge McMahon describes this as part of a greater plan by the Sacklers to first remove value from the companies and then use bankruptcy to obtain third-party releases in exchange for funding a bankruptcy settlement. The goal was “to secure for the Sacklers a release from any liability for past and even future opioid-related litigation, without having to pursue personal bankruptcy.” (p.43).

The Purdue companies filed their bankruptcy on September 15, 2019, and quickly obtained an injunction halting over 400 civil suits against the Sackler family.

The Plan and Shareholder Release

Judge McMahon acknowledges the extraordinary efforts of all of the parties to negotiate a plan, including mediators described by Judge McMahon as “the most experienced and respected mediators in the country.” (p. 47) .The opinion describes the plan in detail.

The Shareholders Release was a key element. In exchange for the Sackler’s $4.275 billion contribution, the plan released “third-party claims against over 1000 individuals and entities related to the Sackler family.” (p.55) The release included “claims that third parties have asserted or might assert in the future against the shareholder released parties,” and that were based on or related to the debtors or their bankruptcies. (p. 56) The release was further limited to claims where the “conduct, omission or liability of any Debtor or any Estate is the legal cause or is otherwise a legally relevant factor.” (p. 56) The Shareholders Release was non-consensual; all current and potential claims connected with OxyContin and other opioids would be covered.

Judge McMahon notes that the non-derivative claims against the released parties were “effectively being extinguished for nothing.” (p. 56) The plan prohibited “value being paid based on causes of action (whether pre-or post-petition) against the Sackler family or other non-debtor for opioid-related claims.” (p.56)

The critical element of these released claims is that they must be claims directly against the released parties arising from an independent duty to the claimant, and not derivative of any claim by or against the debtor.

Confirmation

Judge McMahon describes the bankruptcy judge’s opinion confirming the plan as a “judicial tour de force” delivered only days after a lengthy trial, and addressing “every conceivable legal argument in great detail.” (p.58)

The bankruptcy court’s opinion noted that the voting creditors overwhelmingly supported the plan. Of approximately 120,000 votes cast, “an amount far exceeding the voting in any other bankruptcy case” over 95% of those voting favored the plan. (p.62) It also observed that the failure to approve the settlement and confirmation would result in complex litigation and likely with the liquidation of the case and abandonment of the proposed $4.275 billion contribution by the Sacklers.

Judge McMahon briefly summarizes the various legal issues addressed by the bankruptcy court’s opinion, and then focuses on its justification for the third-party non-consensual releases. For its authority to grant the Shareholders Release, the bankruptcy court relied on the concept of its “necessary or appropriate” power to take actions under Section 105(a), combined with the authority in Section 1123(b)(6) to “include any other appropriate provision [in a plan] not inconsistent with the applicable provisions of this title.” (p. 68) The bankruptcy court also justified the grant of the Shareholders Release based on the “rare” and “unique” character of the case. (p.70)

As described below, Judge McMahon rejects these justifications.

[1] While mentioned only briefly in the opinion, it is important to note that the individual Sacklers have at all times denied any wrongdoing

REASONING
Bankruptcy court did not have jurisdiction to enter a final order on confirmation containing the Shareholders Release.

In the context of addressing the standard of review on appeal, Judge McMahon observes that the Shareholders Release would have permanently resolved certain independent claims against the Sackler family. Because the claims did not stem from the bankruptcy itself, and would not be resolved in the claims-allowance process, the only jurisdiction held by the bankruptcy court over them was “related to” the bankruptcy under 28 U.S.C. Section 157(a), as “non-core.”

Applying the Supreme Court ruling of Stern v. Marshall, 564 U.S. 462 (2011), Judge McMahon concludes that that a non-consensual release by a third party of a claim against a non-debtor that is part of a reorganization plan determines the claim with the same finality as it would if adjudicated at trial. Judge McMahon thus holds that the bankruptcy judge did not have jurisdiction to enter a final order confirming a plan which included such third-party release. Rather, the bankruptcy court should have tendered the proposed findings of fact and conclusions of law to the District Court for approval.

Bankruptcy court had subject matter jurisdiction under the Second Circuit case-law

The appellants challenged whether the bankruptcy court’s “related to” jurisdiction included the ability to grant the challenged Shareholders Release. Judge McMahon concludes that in the Second Circuit the only question a court need ask is whether the action’s outcome might have any conceivable effect on the bankruptcy estate. If the answer is yes, then “related to” jurisdiction exists, no matter how improbable it might be that the actions actually will have an effect on the estate. (p.85)

Judge McMahon held that the bankruptcy court had “related to” jurisdiction because claims against the Sackler family could have resulted in indemnification claims against Purdue and that such claims could have impacted the bankruptcy estate.

No bankruptcy statute either prohibits such releases or grants authority to issue them

Judge McMahon opens her discussion by expressing frustration with the Second Circuit for failing to provide guidance on this critical issue. She explains that, though the Bankruptcy Code has no prohibition against these releases, it also has no statute giving bankruptcy courts the authority to grant them. Judge McMahon analyzes each of the sections on which the bankruptcy court relied and finds they are insufficient to grant such authority. Finally, she explains that there is no “residual authority” or general equitable power of the bankruptcy court that can cure the lack of specific statutory authority in the Bankruptcy Code.

Judge McMahon initially dispenses with the appellants’ argument that Section 524(e) essentially prohibits the Shareholders Release. This section provides that the discharge of a debt in bankruptcy does not affect the liability of another for the same debt. Judge McMahon explains that this section does not prohibit a bankruptcy court from issuing an injunction, but addresses only the automatic effect of a discharge. Also, the section is limited to claims that are discharged in bankruptcy for which a third-party is also liable. It does not affect independent claims of third-parties against non-debtors–the type of claim included in the Shareholders Release.

The only sections in the Bankruptcy Code that specifically address third-party releases are Sections 524(g) and (h) regarding the release of third-party claims in asbestos cases. The sections were enacted after the first of several opinions in the case of Johns Manville, the nation’s leading asbestos manufacturers. MacArthur Co. V. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89 (2nd Cir. 1988) (“Manville I”).

In Manville I, the Second Circuit affirmed the bankruptcy court’s entry of a permanent injunction against suing Manville’s insurance carriers, which had contributed the proceeds of their policies to the plan. Judge McMahon explains Sections 524(g) and (h) in detail, emphasizing that they applied to asbestos cases only. Judge McMahon argues that the limitation is evident both from the text of the statues as well as their legislative history, which expressly states that Congress was not acting regarding other industries (p. 100) Because of the limited scope of the asbestos statutes, Judge McMahon concludes that they cannot be read to imply authority to grant non-debtor releases in other types of cases.

The other Bankruptcy Code sections on which the bankruptcy court relied were Section 105(a), which provides general authority to make orders that are “necessary or appropriate to carry out the provisions of the code,” and three sections related to chapter 11 plans—Sections 1123(b)(5) and (b)(6), and 1129. The bankruptcy judge stated that the sections, along with his “residual authority,” gave him authority to approve the Shareholders Release. Judge McMahon rejects this position, holding that each of the sections “confers on the bankruptcy court only the power to enter orders that carry out other, substantive, provisions of the bankruptcy code.” (p.120)

Early in her opinion, Judge McMahon explains in detail that notwithstanding the general language of Section 105(a) it does not grant any general equitable authority. Relying on the Supreme Court opinions of Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988) and Law v. Siegel, 571 U.S. 415 (2014), as well as several cases in the Second Circuit, Judge McMahon notes that a “bankruptcy court lacks the power to award relief that varies or exceeds the protections contained in the Bankruptcy Code — not even in rare cases, and not even when those orders would help facilitate a particular reorganization.” (p. 101)

The sections related to chapter 11 particularly do not expand that authority. Section 1123(b)(6) describes the possible contents of a plan of reorganization and provides that it may “include any other appropriate provision not inconsistent with the applicable provisions of this title.” Judge McMahon notes that the section is substantially similar to Section 105(a) and concludes that if general authority of Section 105(a) does not allow a bankruptcy court to grant relief beyond specific terms of the Bankruptcy Code, neither does Section 1123(b)(6).

An even more general section relied on by the bankruptcy court is Section 1129(a)(1), which provides that a bankruptcy court “shall confirm a plan only if… the plan complies with the applicable provisions of this title.” Judge McMahon holds that, like Section 1123(b)(6), the section does not grant any substantive authority that could support approving this type of third-party release.

Last, Section 1123(a)(5), also relied on by the bankruptcy court, gives no greater authority. This section provides that a plan must provide adequate means for its implementation. The plan proponents argued that the only way for the debtors to obtain the funds to implement the plan was to grant the Sacklers the Shareholders Release in exchange for the money that the Sacklers were to contribute. This requirement, they argued, meant that the releases were authorized by Section 1123(a)(5) as necessary for the plan’s implementation.

Judge McMahon rejects the argument for a range of reasons, including that Section 1123(a)(5) does not authorize a court to approve such releases “simply because doing so would ensure the funding of a plan.” (p.126) She states that “the fact that Purdue needs the Sacklers to give the money back does not mean that Section1123(a)(5) confers on the Debtors or the Sacklers any right to have the non-debtors receive a release” in exchange for the contribution. (p. 125)

Silence of the Bankruptcy Code does not grant the needed authority.

Judge McMahon rejects the argument that because this type of release is not prohibited it must be permitted. First, she notes that to assume authority from silence is inconsistent with the “comprehensive federal system … to govern the orderly conduct of debtors affairs and creditors rights.” (p. 127) Second, she notes that the type of release being requested includes relieving non-debtors of the types of claims –here for fraud and willful misconduct — that could not be discharged in their own bankruptcies and thus are entirely inconsistent with the Bankruptcy Code. Third, she refers again to Sections 524(g) and (h), which were enacted to allow third-party releases only in asbestos cases, even when there were other mass tort cases pending at the time. Judge McMahon notes that Congress made a conscious decision to exclude other industries, and that its “27 years of unbroken silence” since then “speaks volumes” to Congress’s disinclination to expand the statute.
(p. 129)

Judge McMahon’s review of case law and split in the circuits does not change her analysis.

Judge McMahon reviews the split in the Circuits regarding whether statutory authority exists to grant this type of release. She notes that the Fifth, Ninth and Tenth Circuits reject that bankruptcy court can authorize non-debtor releases outside of the asbestos context, based on Section 524(e). (As noted below, the Ninth Circuit has recently reopened this discussion in its opinion in in re Blixseth v. Credit Suisse, 961 F.3d 1074 (9th Cir. 2020).) She then comments that the remaining Circuits, including the Second, either have not identified any statute that grants such authority other than Sections 105(a) and 1123(b)(6) – which she rejects as inadequate—or have not opined on the issue.

Judge McMahon closes her discussion with an acknowledgment that the result of her invalidating the Shareholders Release will likely be the liquidation of the case and the loss of funding for “desperately need programs to counter opioid addiction.” She notes that, notwithstanding the bankruptcy court’s good intentions, its ability to grant relief to a non-debtor from non-derivative third-party claims could have only been exercised within the confines of the Bankruptcy Code. Because she finds that the Bankruptcy Code “confers no such authority” she holds she must vacate the order confirming the Purdue plan. (p. 137)

AUTHOR’S COMMENT
The primary takeaway from the opinion is that the mechanism of the Bankruptcy Code cannot accommodate every solution to the challenges facing a debtor and its creditors. Here, it is evident that the huge number of stakeholders in the process, and ultimately the bankruptcy court, became vested in trying to provide substantial relief–with the Sacklers’ payment–for the desperate circumstances caused by the opioid crisis. If anything, the Shareholders Release evidences the great forces driving the settlement and plan process. It released over 1,000 people and entities and included claims for fraud and willful misconduct, whether existing or brought in the future–terms that would have been rejected in any other context as overreaching.

Judge McMahon’s opinion provides powerful defenses against such excesses. First and foremost, she reaffirms that any authority of the bankruptcy court must be solidly bound to the Bankruptcy Code itself. While many cases recognize this limitation when applying Section 105(a), Judge McMahon applies it with equal force on all of the other general sections relied on by the bankruptcy court for its claim of “residual authority.”

Until recently, in the Ninth Circuit such third-party releases were not allowed at all on the basis that they were contrary to Section 524(e). In re Blixseth v. Credit Suisse 961 F.3d 1074 9th Cir. 2020) modified that rule and reopened the possibility of including such releases in a chapter 11 plan. In Blixseth, the court considered an exculpation clause in a Chapter 11 plan that released Credit Suisse, a creditor, for liability for post-petition actions “in connection with” among other things, negotiating the plan. The released claims did not include claims derived from the debtor. The court held that, contrary to prior understanding, Section 524(e) did not prohibit such third-party releases, for the same reasons described by Judge McMahon. While the releases in Bixseth included only negligence claims and were narrow in time and the number of parties, substantively, they covered the character of independent claims included in Purdue. The court in Blixseth allowed the releases. It found that both Section105(a) and Section 1123 provided the bankruptcy court with authority to impose such releases on a non-debtor, and that it was justified by the need to limit litigation and “so render the plan viable.” Supra, at p.1085. But, according to Judge McMahon, the referenced sections do not grant such authority, and “plan viability” does not justify granting a third-party release.

What is left open is whether any non-consensual third-party release of non-derivative claims against non-debtors can be approved even when it is limited to negligence claims against specific parties. Under this opinion, the answer is no, since there is no specific statute authorizing it, and neither “residual authority” nor “plan viability” will suffice.

Given the discussion and holdings in Purdue, and the recent 9th Circuit’s opinion in In re Blixseth v. Credit Suisse, the ruling on the likely Purdue appeal will be one to watch.

This review was written by Wendy W. Smith, a partner in Binder & Malter, LLP and a member of the ad hoc group. Editorial contributions were provided by Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.

 

Know someone who would like to receive Insolvency Law Committee e-bulletins? Please visit the California Lawyers Association website to sign up.

Interested in becoming an official member of the Insolvency Law Committee? The application to join the CLA Business Law Section is available online here. Applicants must be Business Law Section members who have been admitted to the California Bar and practicing for at least five years.

 

Best regards,

Insolvency Law Committee

Co-Chair
Christopher D. Hughes
Nossaman LLP
chughes@nossaman.com

Co-Chair
Cathy Ta
Reorg Research, Inc.
cta@reorg.com

Co-Vice Chair
Kit J. Gardner
Law Offices of Kit J. Gardner
kgardner@gardnerlegal.com

Co-Vice Chair
Aaron E. de Leest
Danning, Gill, Israel & Krasnoff LLP
adeleest@danninggill.com

/by

Bankruptcy Venue “Reform” – What Are The Odds This Time?

USA October 5 2021

Here we go again – proposed bankruptcy venue legislation is back after previous “reform” efforts came up empty. For those seeking legislative action, what are the chances for venue reform now?

Venue for bankruptcy cases is governed by 28 U.S.C § 1408, which provides that corporations may file in the district (a) in which their “domicile, residence, principal place of business in the United States, or principal assets in the United States” have been located during a majority of the prior 180 days, or (b) in any district where an affiliate, general partner or partnership has filed. Because of the different bases for venue, a company may have multiple choices where to file its chapter 11 case. For instance, if the company is incorporated in Delaware, like many companies are, venue in Delaware is permitted even if the company is headquartered in another state and otherwise has no connection to or assets located in Delaware. Alternatively, if the company has an affiliated debtor incorporated or located in a state, the company can file in its affiliate’s venue, even if the affiliate is insignificant in size or importance. All of this optionality may lead to “forum shopping,” meaning a company is strategically able to choose where to file its bankruptcy case, based on factors such as favorable case law in the district, the particular judges (and at times the fact that there is only one judge) in the district or the procedures employed in the district for complex cases. These choices can in many cases be dictated by lenders, who view the judges or jurisprudence in those districts as more favorable to their positions. Oftentimes, these choices lead to filings in Delaware, the Southern Districts of New York and Texas, as well as the Eastern District of Virginia—jurisdictions which are favored by debtors and lenders—which has resulted in a concentration of bankruptcy filings, especially by large public companies, in those jurisdictions.

The ramifications of this forum shopping are significant. For instance, many corporate chapter 11 cases are filed far away from the location of the company’s employees and creditors, in jurisdictions where the company only has tangential contact. This may limit the debtor’s employees and smaller creditors from having meaningful access to the proceedings. The concentration of large corporate cases in just a few select jurisdictions may limit diversity of judicial opinions by limiting the judges who are asked to decide complex and novel issues of law. Further, creditors who are sued by debtors—for instance, for recovery of preferential transfers—must defend themselves in jurisdictions with which they have little to no connection, forcing them to hire local counsel and significantly increasing the cost of defense.

These concerns, however, may be outweighed by other factors. For example, many bankruptcy cases use free, online case dockets, and particularly since the onset of COVID-19, increasingly hold hearings via telephone or Zoom. Local creditors are therefore able to stay actively engaged in a bankruptcy case regardless of where the case is filed. Furthermore, reform critics argue that concentration of large bankruptcy cases in select jurisdictions allows complex issues to be expeditiously decided, since the judges in those jurisdictions have substantial experience handling large complex cases. Lastly, it bears noting that although some believe that the integrity of the bankruptcy system is jeopardized with the current venue provisions, a party in interest may seek a change of venue in the interest of justice or for the convenience of the parties.

Previous efforts to reform bankruptcy venue have failed. Most recently, in 2018, Senators John Cornyn (R-Tex.) and Elizabeth Warren (D-MA) introduced the “Bankruptcy Venue Reform Act of 2018.” This bill would have required corporate debtors to file for bankruptcy protection in the district in which their principal assets or principal place of business was located. The bill did not receive a vote in either the House or Senate.

For those favoring venue reform, however, hope springs eternal. On June 28, 2021, Representatives Zoe Lofgren (D-Cal.) and Ken Buck (R-Tex.) introduced the “Bankruptcy Venue Reform Act of 2021” (H.R. 4193). Subsequently, on September 23, 2021, Senators Warren and Cornyn introduced the Senate’s substantively identical version of the “Bankruptcy Venue Reform Act of 2021.” The new bills would require a debtor to file where its headquarters or principal assets are located, severely limit the ability to use affiliates to establish venue and require a debtor to establish by “clear and convincing evidence” that venue in the selected jurisdiction is proper.

What are the chances for this latest bankruptcy venue reform? Unfortunately for reform advocates, the chances appear quite slim for any movement on the current bills and it is likely that the bills will run into strong resistance like prior reform efforts. For instance, right now it is unclear where House Judiciary Committee Chairman Jerrold Nadler (D-NY) stands on venue reform, although Chairman Nadler’s district includes the Southern District of New York, often a direct beneficiary of the current venue rules. Furthermore, even if the bill passed both the House and Senate, it is unclear whether President Biden would sign the bill into law. After all, President Biden is a former Senator from Delaware, a major beneficiary of the current venue rules, and was a strong proponent of the present venue statute.

Squire Patton Boggs – Mark A. Salzberg and Kyle F. Arendsen
/by

Is a Legislative Crackdown Coming on Third Party Releases in Bankruptcy Plans?

USA September 24 2021

One valuable tool in formulating a successful exit from chapter 11 via a confirmed plan is the use of third-party releases. Such releases can take many forms, but the basic idea is that a non-debtor third party contributes property, usually cash, to the debtor or a trust created under the plan, with the cash to be distributed to unsecured claim holders, in exchange for a release of asserted or potential claims those claim holders may assert against the third party (often where there is co-liability with debtor). Generally, the third party wants a blanket release of all claims held by all creditors, especially where those creditors may have a direct cause of action they could assert, in exchange for the cash or other consideration given by the third party. The scope of who can be bound by such a release by the creditors varies by jurisdiction, with some courts permitting such releases in the plan only where each creditor has affirmatively consented to the release, with other courts approving or allowing confirmation of plans that bind all creditors to the release regardless of whether each creditor affirmatively consented or not.

The Bankruptcy Code is silent on whether such releases are permitted, and because they are not expressly prohibited, such provisions are permissible in a plan so long as the provision is consistent with the Bankruptcy Code. See 11 U.S.C. § 1123(b)(6). The only other provision addressing such releases in the current Code (actually, injunctions against pursuit of claims against third parties) is in section 524(g). However, that section is limited by its terms to an injunction against bringing claims for wrongful death, bodily injury or property damage for asbestos exposure.

These releases have become widely used in chapter 11 and are necessary to resolve mass tort cases, like the clergy abuse cases, USA Gymnastics, the Purdue Pharma bankruptcy involving the opioid crisis, and even the pending Boy Scouts of America case. These releases can be very useful in generating recoveries for unsecured creditors who may otherwise be out of the money in more run-of-the-mill cases, such as cases involving officer and director breach of duty claims.

Use of these releases has proved to be controversial, especially with respect to the Purdue Pharma case. In that case, there has been much criticism leveled against the deal struck by the Sackler family to provide cash to Purdue Pharma’s opioid abuse victims over a ten-year period in exchange for a release to be imposed on consenting and non-consenting claimants.. While Bankruptcy Judge Drain has confirmed the plan, thereby approving the releases, there are likely to be appeals from his ruling.

As a direct result of Purdue Pharma case, Democratic members of the US House and Senate have introduced legislation intending to curb such releases. If passed into law, the legislation will have significant ramifications in many bankruptcy cases going forward. The Senate bill, S. 2497, was introduced by Sens. Warren, Durbin and Blumenthal on July 28, 2021. The Senate bill proposes to add a new section 113 to the Bankruptcy Code. In sum, section 113 would prevent the bankruptcy court from approving any provision of a plan of reorganization or otherwise for discharge, release or modification of the liability of a non-debtor party or the bankruptcy estate, and the court may not enjoin the commencement or continuation of any other proceeding to enforce the claim or cause of action, save for a short-term stay. Section (b) of the bill does provide that notwithstanding the prohibition of section (a), the prohibition does not prevent the court from authorizing a sale, transfer or other disposition of property free and clear of claims or interests, the court may continue to prevent third parties from exercising control over a right or interest that is property of the estate, and the prohibition is not a bar against any claim for indemnity, reimbursement or contribution that a non-debtor entity has against a third party once it has been released by the debtor or the estate. Finally, the proposed prohibition does not apply to court approval of a plan providing for the release of a non-debtor in circumstances where clear and conspicuous consent to the release is given by each creditor. But that consent must be individually given and cannot be inferred to be given by acceptance or failing to accept or reject a proposed plan. Moreover, the treatment of similar creditors cannot be different by reason of such entity’s consent or failure to consent.

At first blush, the Senate bill appears to be narrowly targeted to prohibit use of releases in mass tort cases. Among other things it will be impossible or impractical to solicit a release from each claimant. But, if enacted, the legislation could also prevent use of such releases in ordinary commercial cases, except those with only a handful of unsecured creditors. As a result it will be difficult to generate some recovery to otherwise out of the money creditors. Without the ability to deliver creditor releases, non-debtor third parties and their insurers will have no incentive to contribute to the creditor recovery. Moreover, the legislation likely increases the chances of liquidation or sale of assets under section 363, rather than use of a chapter 11 plan to reorganize, because the reorganization process cannot be used to fully implement a collective solution. Hopefully these considerations will be taken into account and the legislation modified to accommodate these concerns.

Fredrikson & Byron PA – Clinton E. Cutler
/0 Comments/by

No Harm, no Foul—With TransUnion v. Ramirez, the Supreme Court Holds that Fed. Rule Civ. P. 23 Does not Permit a Damages Class Where Much of the Class Suffered no Injury

USA June 25 2021

The Vault

Or to put it in legalese—“no concrete harm, no standing.” It does not get more simple than that. On June 25, 2021, the U.S. Supreme Court decided Trans Union v. Ramirez (“Ramirez”), a case involving whether class members who suffer no actual injury can be included in a damages class under Federal Rule of Civil Procedure 23. In a 5-4 decision written by Justice Kavanaugh, the Supreme Court held that they cannot because they do not have standing under Article III of the Constitution. The holding is important because it places limits on Congress’s ability to create statutory schemes that provide for damages in the absence of a concrete injury to potential class members.

In Ramirez, the lower court certified a class encompassing 8,124 absent class members who were allegedly subjected to inaccurate credit reporting by TransUnion, but the vast majority of whom had not actually suffered any injury because their credit reports were never disseminated to any third party. Specifically, the case involved the inaccurate reporting of consumers’ placement on a list of “specially designated nationals” by the Office of Foreign Assets Control (“OFAC”) indicating they were subject to sanctions and with whom business entities were forbidden to transact business. The lead plaintiff Ramirez had attempted to purchase a car from a dealership but was denied the opportunity when a credit report from TransUnion indicated he was on the OFAC list. Ramirez sued and sought to represent a class of 8,124 absent class members, 75% of whom Ramirez conceded suffered no actual concrete injury remotely similar to that sustained by him, when he was denied the opportunity to purchase a vehicle. Indeed, the credit reports of these absent class members had never been distributed to any third party. At most, the vast majority of absent class members were simply informed by TransUnion that their names had been reported on the OFAC list and had been subjected to potentially confusing mailings about the reports and how could they address them.

The lower courts found that the proposed class by Ramirez was certifiable under Rule 23. Specifically, the Ninth Circuit Court of Appeals, over a dissent, ruled that the claims of the lead plaintiff were sufficiently “typical” and that absent class members suffered an “injury” because they had been erroneously notified by mail that they were on OFAC’s sanctions list. Further, the mere possibility that the erroneous reports could have been distributed to third parties “suffic[ed] to show a material risk of harm to the concrete interests of all class members.” Accordingly, the Ninth Circuit Court of Appeals affirmed an adverse trial verdict against TransUnion though it lowered a class-wide punitive damages award.

The Supreme Court reversed. It held that in assessing whether a class member has suffered a “concrete harm” under Article III, as required by its earlier decision in Spokeo v. Robins, courts must “[a]ssess . . . whether the asserted harm has a “close relationship” to a harm traditionally recognized as providing a basis for a lawsuit in American courts – such as physical harm, monetary harm, or various intangible harms including (as relevant here) reputational harm.” In so ruling, the Court placed important restrictions on Congress’s authority to create statutory schemes involving damages where no “concrete harm” has been sustained. Such power would not only violate Article III requirements for bringing suit, but would also infringe upon Executive Branch prerogatives concerning law enforcement and thereby violate the separation of powers. As Justice Kavanaugh wrote, under Article III an injury in law is not an injury in fact. In the instant case, the Court ruled that those class members whose credit reports with the allegedly offending information were never disseminated to third parties suffered no cognizable concrete harm. In addition, the Court ruled that the receipt of potentially confusing mailings from Trans Union likewise did not cause concrete injury. For those class members whose credit reports were disseminated to third parties, the Court recognized that being labeled a “potential terrorist” was analogous to a false and defamatory statement and, therefore, satisfied Article III. The decision is important in that plaintiffs seeking to bring actions in federal courts predicated on statutory damages schemes will also need to demonstrate they sustained a “concrete harm” which, in many cases, they will be unable to do so.

Nelson Mullins Riley & Scarborough LLP – Robert “Bob” J. McGahan, Matthew G. Lindenbaum, Jahmy Graham and Melanie L. Todman

 

Source: https://www.lexology.com/library/detail.aspx?g=95f1974e-e620-4185-b75a-2d437c3046f7&utm_source=Lexology+Daily+Newsfeed&utm_medium=HTML+email+-+Body+-+General+section&utm_campaign=Calbar+business+section+subscriber+daily+feed&utm_content=Lexology+Daily+Newsfeed+2021-06-28&utm_term=

/0 Comments/by

Liquidated Damages – California

May 26, 2021

The following is a case update written by Leonard Gumport analyzing a recent case of interest.

SUMMARY

In Graylee v. Castro, 52 Cal. App. 5th 1107 (2020) (“Graylee”), the California Court of Appeal ruled that California Code of Civil Procedure section 664.6, which allows a court to enter a judgment under the terms of a settlement of pending litigation, does not authorize a court to enter or enforce a judgment that contains an invalid liquidated damages clause. A copy of the Graylee decision is here.

FACTUAL BACKGROUND

In May 2015, John and Rosa Castro (the “Castros”) leased a residential property in Anaheim, California from Fred Graylee (“Graylee”). The monthly rent was $3,195. In June 2018, Graylee served the Castros with a three-day notice to pay rent or quit. In the notice, Graylee alleged that the Castros owed $27,170 in unpaid rent. On July 3, 2018, Graylee filed an unlawful detainer action against the Castros. On August 2018, Graylee filed a first amended complaint, which sought $27,170 in past-due rent, reasonable attorney’s fees, and forfeiture of the lease agreement. In an answer, the Castros disputed Graylee’s complaint and asserted affirmative defenses, including that Graylee had accepted rent from the Castros. Trial was scheduled for October 2, 2018.

On the trial date, Graylee and Castros filed a handwritten stipulation (the “Stipulation”) on a preprinted form for entry of judgment. The trial court approved the Stipulation on the same day. The Stipulation required the Castros to vacate the property by 3:00 p.m. on October 31, 2018, and to leave the property in broom-swept condition. The Stipulation provided that a $28,970 judgment for unpaid rent, damages, and attorney’s fees and costs would be granted against the Castros “only if” they failed to comply with the Stipulation. The Stipulation provided that, if the Castros timely vacated the property, then Graylee would waive the $28,970 money judgment; if the Castros failed to comply, then the full judgment amount of $28,970 would be due. In the Stipulation, the Castros waived all claims against Graylee through the date of the Stipulation.

In January 2019, Graylee filed a motion for entry of a stipulated judgment for $28,970 against the Castros. The motion was supported by a declaration from Graylee’s property manager, who stated that the Castros vacated the property one day after the October 31, 2018 deadline and did not leave the property in broom-swept condition. The declaration did not provide details about how the property fell short of the broom-swept condition requirement. The Castros opposed Graylee’s motion and alleged that they had timely vacated.

On June 10, 2019, after an evidentiary hearing, the trial court found that the Castros did not vacate the property by the October 31, 2018 deadline. Pursuant to the Stipulation, the trial court entered a judgment for $28,970 against the Castros. On September 26, 2019, the trial court vacated that judgment and entered an amended judgment (“Stipulated Judgment”) for $28,970 against the Castros pursuant to the Stipulation. They appealed. On July 13, 2020, the Court of Appeal reversed the Stipulated Judgment.

REASONING

In Graylee, the Court of Appeal began its analysis by deciding whether Code of Civil Procedure section 664.6, which authorizes stipulated judgments to settle pending litigation, is an exception to Civil Code section 1671, which prohibits enforcement of unreasonable liquidated damages clauses. Section 664.6 allows a court to enter a judgment under the terms of a settlement agreement, and, if requested, to retain jurisdiction to enforce the settlement.

Graylee rejected the landlord’s contention that section 664.6 is an exception to the prohibition in Civil Code section 1671(b) on unreasonable liquidated damages clauses. Section 1671(a) states that it “does not apply in any case where another statute expressly applicable to the contract prescribes the rules for determining the validity” of the liquidated damages provision. The terms of section 664.6 do not allow a court to endorse or enforce a provision of a settlement agreement or stipulation that is illegal, contrary to public policy, or unjust. Unenforceable liquidated damages provisions are void as against public policy. A stipulated judgment that includes an unlawful liquidated damages provision is void and may be vacated. Graylee, 52 Cal. App. 5th at 1114.

The Stipulation contained a liquidated damages provision, even though the Stipulation did not use the words “liquidated damages.” Liquidated damages are the compensation to be paid in the event of a breach of contract, the amount of which is fixed by agreement and may not ordinarily be altered when the damages actually resulting from the breach are different from the agreed upon amount. Courts look beyond the language of a contract to determine the actual circumstances of a liquidated damages clause. The $28,970 monetary provision of the Stipulation was a liquidated damages clause because the Stipulation “predetermined the amount of damages the landlord would be entitled to receive if the tenants breached their settlement obligations.” Id. at 1114. It was irrelevant that the Stipulation did not use the phrase “liquidated damages.” Id.

Under Civil Code section 1671(b), a liquidated damages provision “is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.” The liquidated damages provision must represent a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained. Otherwise, the clause will be construed as an unenforceable penalty. Id. at 1115.

The Stipulated Judgment was unenforceable because it constituted an unenforceable penalty, not valid liquidated damages. “[A] court cannot enter a judgment that contains an unenforceable liquidated damages clause.” Id. at 1113. There was no meaningful relationship between the $28,970 amount of the Stipulated Judgment and the Castros’ failure to vacate by October 31, 2018 or to leave the vacated premises in broom-swept condition. In addition, the record did not show any effort by the parties to reasonably anticipate the amount of damages that might flow from a breach of the Stipulation. Similarly, nothing in the record showed the “the landlord’s chances to completely succeed at trial and recover all the unpaid rent allegedly owed.” Id. at 1118.

Graylee distinguished Jade Fashion & Co., Inc. v. Harkham Industries, Inc., 229 Cal.App.4th 635 (2014). In that case, the amount owed was undisputed, and the settlement was not an agreement to settle a disputed claim. Instead, the settlement was an agreement to forbear on the collection of a debt that was admittedly owed. Graylee, 52 Cal. App. 5th at 1117. In contrast, the Stipulation was a compromise of disputed claims, and the Castros never admitted that they owed $27,100 in unpaid rent. Id. at 1118.

In reversing and remanding, Graylee directed the trial court, among other things, to determine “whether the landlord suffered any actual damages as a result of the tenants’ breach of the stipulation.” Id. at 1119.

AUTHOR’S COMMENTS

Three takeaways from Graylee are: (1) a stipulated judgment that contains an invalid liquidated damages provision (or that results from an invalid liquidated damages provision in an underlying settlement) is not enforceable; (2) stipulated judgments and other settlements that provide for contingent reductions or increases in settlement payments must withstand a liquidated damages analysis, which should be made by the parties at the time of negotiating those payment contingencies, in the course of drafting the liquidated damages provision in the settlement; and (3) in determining whether a stipulated judgment or other settlement contains an unenforceable penalty, the court will be entitled to examine the underlying circumstances.

EDITOR’S COMMENTS

As a retired judge who has mediated many bankruptcy cases, both while active and in retirement, I find this holding by the California Court of Appeal troubling. A common way to settle pending litigation is an agreement for the defendant to pay a sum certain in installments. As an incentive for the defendant to perform, the agreement often has a provision that if the defendant defaults, after appropriate notice and opportunity to cure, a stipulated judgement for a sum greater than the installment sum will be entered, giving credit for any payments made. Under the reasoning ofGraylee, without more, such stipulated judgment would be found unenforceable as based on liquidated damages. One practice tip to avoid that consequence might be to structure the agreement to pay as a forbearance on collection of the greater amount (to be included in the Stipulated Judgment upon default). The Graylee court indirectly suggests this alternative by distinguishing the holding of Jade Fashion & Co v. Harkham Industries, Inc. by saying in that case the amount owed was undisputed and the agreement was a forbearance agreement. Perhaps my alternative will not work, however, where the amount owed is disputed, which is usually the case. The Court of Appeal implies that a party settling litigation with installment payments and forbearance must admit to the amount of damages before a stipulated judgment for a greater sum entered after default will be enforceable. Since almost all mediated settlements are premised on no admission of liability by the settling parties, if that admission is mandatory, this tool for settling cases may be disappearing.

These materials were written by Leonard L. Gumport of Gumport Law Firm, PC in Pasadena (lgumport@gumportlaw.com). Editorial contributions were provided by Meredith King of Higgs|Fletcher|Mack in San Diego (kingm@higgslaw.com) and the second edit and Editor’s Comment were provided by the Hon. Meredith Jury, retired Bankruptcy Judge and member of the ILC (majury470@gmail.com).

Best regards,

Insolvency Law Committee

Co-Chair
Michael W. Davis
DTO Law
mdavis@dtolaw.com

Co-Chair
Michael J. Gomez
Frandzel Robins Bloom & Csato, L.C.
mgomez@frandzel.com

Co-Vice Chair
Cathy Ta
Reorg Research, Inc.
cta@reorg.com

Co-Vice Chair
Christopher D. Hughes
Nossaman LLP
chughes@nossaman.com

Source: https://calawyers.org/section/business-law/

/0 Comments/by

Rent deferrals in bankruptcy during the COVID-19 pandemic

DLA Piper

USA May 24 2021

The COVID-19 pandemic created unprecedented disruptions across the global economy, perhaps most severely in the retail sector. Shelter-in-place orders, government-mandated closures and other restrictions drastically reduced or entirely wiped out revenue streams, resulting in an increased number of bankruptcy filings by retail debtors.

While bankruptcy generally provides a breathing spell from creditors, debtors usually must continue paying rent to landlords. To help address cash flow and liquidity issues caused by the pandemic, some debtors have sought to defer their commercial lease obligations, including rent, in addition to attempting to invoke force majeure clauses and/or the “frustration of purpose” doctrine. These efforts have achieved mixed success.

A. Section 365(d)(3) of the Bankruptcy Code1

Section 365(d)(3) of the Bankruptcy Code generally requires that debtors remain current on lease obligations during bankruptcy, subject to a limited exception that allows the court to defer obligations for 60 days after the petition date upon a showing of cause.2,3

Prior to the COVID-19 pandemic, section 365(d)(3) had been most thoroughly discussed in the context of stub rent, including whether a debtor could defer paying stub rent until confirmation of a plan.4 In a leading case, the Circuit City5 court ruled that stub rent is a post-petition obligation entitled to treatment as an administrative expense of the bankruptcy estate, but that it did not have to be paid at the beginning of the case under section 365(d)(3). Instead, debtors could pay stub rent upon plan confirmation, with other administrative expenses.

The court noted that while section 365(d)(3) requires a debtor to timely perform post-petition lease obligations, the obligation to pay stub rent arose before the bankruptcy filing, when the monthly rent came due. The court noted that the Bankruptcy Code provides no express remedy for failing to comply with section 365(d)(3), including nothing that would elevate a landlord’s claim to “super-priority” status requiring immediate payment before other administrative expenses.

B. Pier 1 Imports

One of the first cases to address lease obligations during the pandemic was In re Pier 1 Imports.6 Pier 1 Imports filed for Chapter 11 bankruptcy on February 17, 2020. The debtors initially anticipated only minor disruptions due to the virus’s impact on Chinese suppliers. The court wrote, “No constituency in these cases predicted that the world would effectively grind to a halt.”7 By the end of March, however, the company was forced to close nearly all its retail outlets due to stay-at-home orders and mandated closures of non-essential businesses.

Pier 1 filed a motion asking to pay only “critical expenses,” such as insurance, utilities, and security, for a “Limited Operations Period.” During that period, certain landlords would not receive rent, notwithstanding the terms of the leases or section 365(d)(3). Not surprisingly, numerous landlords objected.

The court granted Pier 1’s motion and allowed the debtors to defer paying rent. The court extensively discussed the unprecedented nature of the pandemic, described as “a temporary, unforeseen, and unforeseeable glitch in the administration of the Debtors’ Bankruptcy Cases.”8 Recognising the “extraordinary nature of the relief” it was granting, the court relied on the broad equitable powers granted by section 105(a) of the Bankruptcy Code.9 The court acknowledged the apparent inconsistency with section 365(d)(3), but found, in reliance on the former Circuit City decision, that section 365(d)(3) does not provide a separate remedy if a debtor cannot comply with its rent obligations. The court concluded that failing to pay rent does not result in a super-priority claim that must be paid immediately, but only an administrative expense.

Critically, the court noted the lack of a realistic alternative – Pier 1 could not generate sufficient revenue to pay rent because it was prohibited from opening its stores, and it could not liquidate inventory while the stores were closed. The court noted that landlords were the only objectors, though lenders, thousands of furloughed employees, and suppliers were also negatively affected.

At least one other court, in Bread & Butter Concepts, fully adopted the reasoning from Pier 1 and granted similar relief.10 In that case, the court similarly noted that only landlords had objected, and found that the “unprecedented circumstances require temporary relief to preserve the Debtors’ opportunity to benefit from the reorganisation afforded by Chapter 11.”11

C. CEC Entertainment

On the other end of the spectrum, in December 2020, the court in In re CEC Entertainment Inc. ruled that section 365(d)(3) prohibits rent deferrals.12 The debtors operated a nationwide chain of Chuck E. Cheese venues, and had filed for bankruptcy on June 24, 2020. In early August, the debtors filed a motion to abate rent payment for 141 locations that continued to be impacted by governmental orders or regulations.

The CEC debtors presented three arguments: (1) sections 365(d)(3) and 105(a) give the court equitable power to alter post-petition rent obligations (i.e. the Pier 1 argument); (2) government orders eliminating or reducing operations triggered force majeure clauses in the leases; and (3) debtors should be relieved from paying rent by the “frustration of purpose” doctrine. By the time of the court’s ruling, the debtors had reached agreement with all but 6 landlords.

The court denied the motion, holding that section 365(d)(3) unambiguously requires timely performance of all lease obligations during bankruptcy. The court found that it could not grant relief that directly violated a provision of the Bankruptcy Code. In rejecting the “broad equitable powers” arising under section 105(a) argument, the court noted that such powers are not unlimited. Rather, section 105(a) only authorizes “bankruptcy courts to fashion such orders as are necessary to further the substantive provisions of the Code.” Because the motion directly contradicted section 365(d)(3), the court could not approve lease deferrals. The court expressly disagreed with the holding in Pier 1, though noted that such disagreement was perhaps only “on the margins.” The court also rejected the debtors’ force majeure and frustration of purpose arguments under applicable state law and the terms of the relevant leases.

D. Conclusion

These cases are just two examples of how courts and restructuring professionals have sought to address the continuing impact of the pandemic on retail operations for companies in bankruptcy. Many cases involve consensual agreements between the affected parties that did not require the court to make a substantive decision. These issues will continue to develop as the long-term impact of the pandemic continues to be addressed through ongoing bankruptcy cases.

DLA Piper – Aaron Applebaum

 

Source: https://www.lexology.com/library/detail.aspx?g=ec726ef0-f986-470e-8d3e-d03e693b7b46&utm_source=Lexology+Daily+Newsfeed&utm_medium=HTML+email+-+Body+-+General+section&utm_campaign=Calbar+business+section+subscriber+daily+feed&utm_content=Lexology+Daily+Newsfeed+2021-05-26&utm_term=

/0 Comments/by

Notice by Email Was Sufficient for Miller Act Bond Claim

USA May 7 2021

We knew this day would come, since email is now the primary means of written communication. A material supplier made a payment bond claim solely via email. No letter was sent by mail, much less sent by certified mail as required under the Maryland Little Miller Act for payment bond claims. And yet, a federal District Court judge has held that notice by email was sufficient, and denied the surety’s motion for summary judgment.

The plaintiff was a material supplier to a first-tier sub, providing materials from January to May 2019. On October 30, 2019, the plaintiff sent an email to the GC concerning the unpaid amounts, and attached documents to back up its claim. The email identified the project, the first-tier sub and the amount due. The supplier also asked for a copy of the payment bond, which the GC eventually provided.

The surety provided the supplier with a proof of claim form, which the supplier submitted back to the surety. There was no dispute that the supplier never sent any notice by certified mail. (Although not clear from the decision, it may be that all communications were via email.)

The Maryland payment bond statute states that notice “shall be sent by certified mail to the contractor.” This was admittedly not done. But the judge noted:

this Court must still look to the purpose of the statute to determine whether email is a sufficient means of delivery. In this case, a liberal construction of the means of delivery does not contravene the remedial purpose of the statute. The purpose of certified mail is to ensure receipt of the claim. In this case, receipt of the claim was ensured by email which provided a digital history of delivery.

Further, there was no argument about the timing, content or even receipt of the email notice. The only argument was to the form of delivery of the notice. Since the GC and surety had received timely notice from the supplier with the pertinent information provided, the delivery of that notice by email was found to satisfy the purpose of the payment bond law.

The case is Johnson-Lancaster & Assocs. v. H.M.C., Inc., 2021 U.S. Dist. LEXIS 83566 (D. Md., April 29, 2021) (paywall).

Commonsense Construction Law LLC – Stanley A. Martin

 

Source: https://www.lexology.com/library/detail.aspx?g=c1f3f777-7602-41b6-99b7-9e622c5353a1&utm_source=Lexology+Daily+Newsfeed&utm_medium=HTML+email+-+Body+-+General+section&utm_campaign=Calbar+business+section+subscriber+daily+feed&utm_content=Lexology+Daily+Newsfeed+2021-05-11&utm_term

/0 Comments/by

Useful Links

Social Media

Get in Touch