U.S. Supreme Court Ends Chevron Deference

June 28 2024
On June 28, 2024, the Supreme Court of the United States jettisoned the Chevron doctrine, overruling a 40-year-old case that had long served as the foundation for American administrative law. In the consolidated opinion in Loper Bright Enterprises, Inc. v. Raimondo and Relentless, Inc. v. Department of Commerce, the Supreme Court declared that, instead of deferring to agency interpretations of ambiguous statutes, courts now must exercise their “independent judgment” to determine whether an agency acted within its statutory authority.

Although the Court held that Loper Bright Enterprises does “not call into question prior cases that relied on the Chevron framework,” it will still likely create waves for every federally regulated industry in the United States. How much of an impact this decision will have will likely be discussed for years to come. In the meantime, companies are encouraged to review any recently issued regulations to determine if the agency acted within its statutory authority under this post-Chevron, nondeferential analysis.

The Chevron Doctrine

In 1984, the Supreme Court decided Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc. In that case, the Court held that where a “statute is silent or ambiguous with respect to the specific issue” before an agency, courts “may not substitute [their] own construction of a statutory provision for a reasonable interpretation made by” the agency. In so holding, the principle of “Chevron deference” was born. Chevron deference required courts to analyze an agency’s construction of a statute using a two-step test. In step one, courts determined whether the statutory language at issue was “clear” or “ambiguous.” If it was clear, that language controlled, and an agency could not deviate from it. But if it was ambiguous, in step two, courts were to defer to the agency’s interpretation of the statutory scheme that Congress “entrusted [it] to administer,” as long as that interpretation was “permissible.” Chevron deference gave federal agencies significant discretion to pass rules based on their reasonable interpretations of arguably ambiguous federal statutes.

The Regulation Involved in Loper and Relentless

Both Loper and Relentless challenged a regulation promulgated by the National Marine Fisheries Service (NMFS) under the Magnuson-Stevens Fishery Conservation and Management Act (MSA). That statute gives the Secretary of Commerce and the NMFS the authority to require commercial fishing vessels to “carry” federal observers on the vessel to ensure that the vessel is complying with federally approved fishery management plans.

Using its regulatory power, NMFS issued a regulation that requires herring fishermen to carry federal observers on approximately 50 percent of their fishing trips. The regulation also provided that, while the federal government would cover the daily salary of some observers, the vessel owners would be required to pay the salaries of the other, nonfunded observers.

Herring fishermen challenged the regulation, arguing that the NMFS lacked authority to require the vessel owners to pay the salaries of the mandated observers. In the two cases in which the Supreme Court granted certiorari, the U.S. Courts of Appeals for the First Circuit and for the District of Columbia disagreed. In Relentless, the First Circuit held that the MSA authorized the NMFS’s regulation without deciding whether the statute was ambiguous, implicating Chevron step two. In Loper Bright Enterprises, the D.C. Circuit held that the statute was ambiguous, meaning the NMFS’s regulation was lawful because it was reasonable.

The Supreme Court Overruled Chevron for Future Regulatory Challenges

In Loper Bright Enterprises, the Supreme Court held that Chevron deference is inconsistent with the judiciary’s constitutional authority to say what the law is. Deference is also inconsistent with the Administrative Procedure Act’s (APA) requirement that courts “exercise their independent judgment” to decide if an agency has acted pursuant to its statutory authority. The Court leaned on the APA’s provision that “courts, not agencies will decide ‘all relevant questions of law’” touching on agency action. Neither the Constitution nor the APA allows courts to abdicate that role just because a statute is ambiguous.

To reach this conclusion, the Court analyzed decades of precedent before and after Chevron, both to demonstrate that Chevron was an aberration at the time it was issued and to show its subsequent unworkability.

The Court held that the fatal flaw in the Chevron principle was the assumption that statutory ambiguity is a delegation of authority to the agency. It rejected that assumption. The Court also explained that an agency’s subject matter expertise does not make it more qualified than the federal judiciary to interpret a statute.

Although the Court has left Chevron behind, it expressly held that regulations previously upheld under the Chevron framework are subject to stare decisis.

The Court also recognized that Congress may still confer discretionary authority on agencies to prescribe rules. In such circumstances, the role of a reviewing court is to ensure that the agency has acted within the boundaries of that delegated authority and has engaged in the reasoned decision-making required by the APA.

Finally, although courts will no longer automatically defer to an agency’s interpretation, courts can still treat the agency’s interpretation as persuasive, particularly if it is thorough, well-reasoned and consistent with other agency pronouncements.

Implications

The Court’s decision to overrule Chevron is a momentous change in how American courts approach issues relating to administrative law. Given the large number of regulated industries in the United States, the Court’s decision has the potential to affect every federally regulated industry, including education, healthcare, tax, automotive, environmental, farming and securities, to name a few. The decision will have a major impact on administrative agencies’ ability or appetite to regulate in areas that are not obviously within their statutory authority and may embolden businesses who are interested in challenging agency actions affecting their respective industries.

Duane Morris LLP – Stephen H. Sutro, Robert M. Palumbos, John M. Simpson, Drew T. Dorner and Leah Mintz

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Supreme Court’s Purdue Decision Requires Nationwide Adoption of 5th Circuit Bankruptcy Practice on Third-Party Releases

June 28 2024
On June 27, 2024, the Supreme Court issued its opinion in Harrington v. Purdue Pharma L.P., 603 U.S. ____ (2024) holding that the Bankruptcy Code does not allow for the inclusion of non-consensual third-party releases in chapter 11 plans. This decision settles a long-standing circuit split on the propriety of such releases and clarifies that a plan may not provide for the release of claims against non-debtors without the consent of the claimants. By ruling that non-consensual releases of claims against non-debtors are not permitted, the Supreme Court has ended the common practice of providing for such releases in bankruptcy cases pending in bankruptcy courts within the Second, Third and Fourth Circuits, among others. The Court made clear, however, that it was not calling into question the propriety of consensual third-party releases. As the Fifth Circuit has long prohibited non-consensual third-party releases (see, e.g., In re Pacific Lumber Co., 584 F.3d 229, 251-53 (5th Cir. 2009)), this decision is unlikely to have much, if any, effect on bankruptcy practice in the Fifth Circuit. However, plan proponents in bankruptcy courts within other federal judicial circuits, including those in the Second, Third and Fourth Circuits, which include New York, New Jersey, Delaware and Virginia, will now be required to obtain consent for third-party releases.

The Supreme Court has left open the question of what constitutes consent for a consensual release, leaving unaddressed disputes that have arisen as to the propriety of so-called “opt-out” releases whereby third parties that take no action may be deemed to have consented to releases of non-debtors.

Facts of the Case

The Purdue Pharma case stems from the widespread opioid epidemic, specifically, Purdue’s blockbuster drug OxyContin. While marketed as being less addictive and safe for more general use, those claims turned out to be false, leading to federal criminal charges, a felony guilty plea and a tsunami of litigation against Purdue and its owners, the Sackler family. In anticipation of this litigation, the Sacklers began extracting money from Purdue, ultimately distributing $11 billion among themselves before putting the company and several affiliates into bankruptcy in 2019 in the Southern District of New York.

Once in bankruptcy, the Purdue debtors, the Sacklers, and certain other parties reached a settlement under which the Sacklers would contribute $4.325 billion (later increased to up to $6 billion) to fund recoveries to creditors, including opioid claimants. Substantially all of such payments would be made over time to state agencies. Individual claimants would receive payments from a base amount of $3,000 up to a ceiling of $48,000, before deductions for attorney’s fees. In return, the Sacklers demanded, and received, releases of all claims the Purdue debtors might have against them, as well as provisions in the plan that would release and forever enjoin any claims that could be brought by third parties against the Sacklers and any entities under their control. Importantly, the claims held by third parties would be released and enjoined regardless of whether the claimants approved of the plan, consented to the releases or even participated in the bankruptcy case. Fewer than 20% of eligible creditors participated in the plan voting process.

Several parties, including the United States Trustee (the petitioner in this case), objected to the plan and the third-party releases. The Bankruptcy Court overruled the objections and approved the plan along with the third-party releases for the Sacklers. The US Trustee and others appealed the decision to the District Court, which reversed the Bankruptcy Court holding that “[n]othing in the law . . . authorized the bankruptcy court to extinguish claims against the Sacklers without the consent of the opioid victims who brought them.” Harrington v. Purdue Pharma L.P., 603 U.S. ____, 5 (2024). The plan proponents, including the Purdue debtors, the Sacklers and other creditors who supported the plan, then appealed to the Second Circuit. The Second Circuit reversed the District Court and reinstated the Bankruptcy Court’s confirmation order. The Second Circuit noted the existing split among the circuit courts of appeal, including the Fifth, Ninth and Tenth Circuit precedent that prohibited non-consensual third-party releases. Second Circuit precedent did allow for non-consensual third party releases in appropriate circumstances, however, and the Second Circuit held that the relevant standards were satisfied under Purdue’s plan. The US Trustee then appealed to the Supreme Court, which first stayed the confirmation order and ultimately reversed the Second Circuit.

Analysis

The Supreme Court’s analysis focused on section 1123(b) of the Bankruptcy Code. That section lists certain things that a chapter 11 plan may do. Specifically, it provides that “a plan may–

(1) impair or leave unimpaired any class of claims, secured or unsecured, or of interests;

(2) subject to section 365 of this title, provide for the assumption, rejection, or assignment of any executory contract or unexpired lease of the debtor not previously rejected under such section;

(3) provide for—

(A) the settlement or adjustment of any claim or interest belonging to the debtor or to the estate; or

(B) the retention and enforcement by the debtor, by the trustee, or by a representative of the estate appointed for such purpose, of any such claim or interest;

(4) provide for the sale of all or substantially all of the property of the estate, and the distribution of the proceeds of such sale among holders of claims or interests;

(5) modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims; and

(6) include any other appropriate provision not inconsistent with the applicable provisions of this title.”

11 U.S.C. § 1123(b). As the Supreme Court noted, the only provision of this section that could possibly authorize the inclusion of a non-consensual third-party release is subsection 6, the catchall provision. Purdue and the other plan proponents argued that this subsection permits a plan to include any term not expressly forbidden under the Bankruptcy Code. And since nothing in the Bankruptcy Code specifically prohibits non-consensual third-party releases, such releases are therefore permitted under section 1123(b)(6).

The Supreme Court rejected this argument holding that the phrase “any other appropriate provision” had to be read in concert with the other five subsections of section 1123(b). And since all five of those subsections address rights and claims either belonging to or held against the debtor, the sixth subsection “cannot be fairly read to endow a bankruptcy court with the ‘radically different’ power to discharge the debts of a nondebtor without the consent of affected nondebtor claimants.” Purdue Pharma, 603 U.S. at 11.

The Court additionally noted that the Bankruptcy Code’s discharge provisions typically apply only to the debtor and not to third parties. Indeed, section 524(e) of the Bankruptcy Code specifically states that “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” 11 U.S.C. § 524(e). (It is this provision of the Bankruptcy Code that the Fifth Circuit focused on in concluding that non-consensual third-party releases were not allowed. See In re Pacific Lumber, 584 F.3d at 251-53.) The Court also noted that Congress had specifically allowed for asbestos claims against third parties to be discharged under section 524(g). The inclusion of this specific provision suggests that Congress did not intend to allow other types of claims against third parties to be discharged.

Both sides also asserted policy arguments in favor of their respective interpretations of the Bankruptcy Code. The plan proponents argued that non-consensual third-party releases are an important tool to achieve consensual resolutions in bankruptcy that would otherwise be impossible. In this case, the Sacklers made it clear that they would not contribute any funds for creditor recoveries without getting full releases. Without that settlement, argued the plan proponents, individual creditors would be forced to engage in costly and uncertain litigation, with no guarantee of recovery. On the other hand, the settlement under the plan would guarantee recoveries to all creditors, including opioid claimants. The US Trustee, however, argued that allowing non-consensual third-party releases would allow tortfeasors to win immunity from claims they otherwise couldn’t discharge in bankruptcy and without having to file for bankruptcy themselves. This would allow wealthy individuals and corporations to abuse bankruptcy as a way to avoid liability for mass torts. While the Court recognized the merits of both sides’ policy arguments, it refused the invitation to decide between them noting that such policy decisions are for Congress to debate and decide.

Importantly, the Court made clear that nothing in its opinion should be construed as calling into question the propriety of consensual third-party releases, nor did the Court offer any opinion on what constitutes a consensual third-party release. Throughout the opinion, the Court repeatedly emphasized that it was ruling solely on whether non-consensual third-party releases could be included in a plan. The Court further noted that the case before it featured a stayed and unconsummated plan, and that it was not opining upon whether a fully consummated plan that featured non-consensual third-party releases could be unwound. This essentially preserves any arguments regarding equitable mootness for substantially consummated plans.

Bottom Line

Bankruptcy courts and practitioners in the Fifth Circuit should not see much, if any, effect from this ruling. The Fifth Circuit has long prohibited non-consensual third-party releases in chapter 11 plans. Plans proposed in courts in the Fifth Circuit routinely feature third-party releases, but provide every party the opportunity to opt-out of such releases. Solicitation materials provided in such cases make clear that the plan contains such provisions and highlight the recipient’s ability to opt out of the releases. Such procedures have so far been treated as consensual releases and are routinely approved.

The Supreme Court made quite clear in its opinion that the Bankruptcy Code prohibited third-party releases without the consent of the affected claimants. It further highlighted that it was not opining on the appropriateness of consensual releases or the procedures behind them. In light of these clear statements, it is unlikely that courts in the Fifth Circuit will deviate from established practices regarding third-party releases. Instead, courts in the Fifth Circuit will likely continue the practice of providing notice and an opportunity to opt out as a procedure for seeking approval of consensual third-party releases in chapter 11 plans.

However, plan proponents in other jurisdictions, including those within the Second, Third and Fourth Circuits, now will need to show consent from affected claimants as a condition to approval of third-party releases contained in chapter 11 plans. Courts in these Circuits have taken different positions regarding whether notice and an opportunity to opt out represents adequate consent to be bound by third-party releases in chapter 11 plans, or whether an affirmative opt in is required to manifest consent. As non-consensual releases are no longer permitted, courts may consider issues concerning consensual non-debtor releases with more frequency in the aftermath of the Purdue Pharma decision.

Hunton Andrews Kurth LLP – Tyler P. Brown, Brian M. Clarke, Timothy A. Davidson II, Phillip J. Eskenazi, Philip M. Guffy, Jason W. Harbour, Gregory G. Hesse and Robert A. Rich

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Fifth Circuit: Recent U.S. Supreme Court Ruling Did Not Alter Mootness Requirements for Unstayed Bankruptcy Sale Orders

May 30 2024
Section 363(m) of the Bankruptcy Code offers powerful protection for good-faith purchasers in bankruptcy sales because it limits appellate review of an approved sale, irrespective of the legal merits of the appeal. Specifically, it provides that the reversal or modification of an order approving the sale of assets in bankruptcy does not affect the validity of the sale to a good-faith purchaser unless the party challenging the sale obtains a stay pending its appeal of the order. That is, section 363(m) renders an appeal “statutorily moot” absent a stay of the sale order. Until 2023, bankruptcy and appellate courts disagreed as to whether this provision is jurisdictional—meaning that it cannot be waived and an appellate court lacks jurisdiction to hear any appeal of an unstayed sale or lease authorization order—or instead a defense that can be invoked by the proponents of the sale (e.g., the debtor, the bankruptcy trustee, or the purchaser) on appeal subject to waiver, forfeiture, and similar doctrines.

The U.S. Supreme Court settled this question in 2023 when a unanimous Court ruled in MOAC Mall Holdings LLC v. Transform Holdco LLC, 598 U.S. 288 (2023) (“Transform Holdco”), that section 363(m) is not jurisdictional. But good-faith purchasers in bankruptcy need not despair; the U.S. Circuit Court for the Fifth Circuit has declared that “Section 363(m) is alive and well” following Transform Holdco.

In Matter of Fieldwood Energy LLC, 93 F.4th 817 (5th Cir. 2024), the Fifth Circuit addressed the impact of the Supreme Court’s decision on statutory mootness under section 363(m). There, the Fifth Circuit affirmed the lower court’s dismissal of an appeal under section 363(m) because the challengers failed to obtain a stay pending appeal. The challenge was brought by certain sureties whose subrogation rights were canceled as part of a “free and clear” bankruptcy asset sale. According to the Fifth Circuit, because the cancellation of the subrogation right was “an integral” part of the sale transaction, absent a stay, the appeal was statutorily moot under section 363(m). Nothing in the Supreme Court’s ruling in Transform Holdco, the Fifith Circuit reasoned, changed that application of section 363(m).

Section 363(m) of the Bankruptcy Code and Statutory Mootness

In general, “mootness” is a doctrine that precludes a reviewing court from reaching the underlying merits of a controversy. An appeal can be either constitutionally, equitably, or statutorily moot. Constitutional mootness is derived from Article III of the U.S. Constitution. In the interest of judicial economy, it limits the jurisdiction of federal courts to actual cases or controversies and precludes adjudication of cases that are hypothetical or merely advisory.

The court-fashioned remedy of “equitable mootness” bars adjudication of an appeal when a comprehensive change of circumstances has occurred such that it would be inequitable for a reviewing court to address the merits of the appeal. In bankruptcy, appellees often invoke equitable mootness as a basis for precluding appellate review of an order confirming a chapter 11 plan that has been “substantially consummated.”

An appeal can also be rendered moot (or otherwise foreclosed) by statute. Section 363(m) of the Bankruptcy Code provides as follows:

The reversal or modification on appeal of an authorization [of a sale or lease of property in bankruptcy] does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.

11 U.S.C. § 363(m).

Section 363(m) provides powerful protections for good-faith purchases in bankruptcy sales by limiting appellate review of the decision. See Made in Detroit, Inc. v. Official Comm. of Unsecured Creditors of Made in Detroit, Inc. (In re Made in Detroit, Inc.), 414 F.3d 576, 581 (6th Cir. 2005) (“‘Section 363(m) protects the reasonable expectations of good faith third-party purchasers by preventing the overturning of a completed sale, absent a stay, and it safeguards the finality of the bankruptcy sale.'”) (quoting Official Comm. of Unsecured Creditors v. Trism, Inc. (In re Trism, Inc.), 328 F.3d 1003, 1006 (8th Cir. 2003)). The provision serves the interests of finality and certainty in bankruptcy sale transactions and encourages bidding for estate property. See In re Sneed Shipbuilding, Inc., 916 F.3d 405, 409 (5th Cir. 2019) (“If deference were not paid to the policy of speedy and final bankruptcy sales, potential buyers would not even consider purchasing any bankrupt’s property.”) (internal citations omitted); In re Palmer Equip., LLC, 623 B.R. 804, 808 (Bankr. D. Utah 2020) (section 363(m)’s protection is vital to encouraging buyers to purchase the debtor’s property and thus ensuring that adequate sources of financing are available).

The federal circuit courts of appeals have disagreed over whether section 363(m) is jurisdictional, such that the failure to obtain a stay pending appeal of a sale order deprives an appellate court of jurisdiction to hear the appeal outside of the limited issue of whether the sale was made to a good-faith purchaser. Compare Su v. C Whale Corp. (In re C Whale Corp.), 2022 WL 135125, *4 (5th Cir. Jan. 13, 2022) (section 363(m) is jurisdictional and precludes an appeal of an unstayed order approving a bankruptcy sale); and Sears v. U.S. Trustee (In re AFY), 734 F.3d 810, 816 (8th Cir. 2013) (mootness under section 363(m) deprives an appellate court from hearing an appeal of an unstayed sale order) with Reynolds v. ServisFirst Bank (In re Stanford), 17 F.4th 116, 122 (11th Cir. 2021) (“Statutory mootness under 363(m) … is not jurisdictional. Though it provides a defense against appeals from bankruptcy court orders, ‘even an ironclad defense, does not defeat jurisdiction.'”). As noted previously, the Supreme Court resolved this circuit split in Transform Holdco.

Fieldwood Energy

Fieldwood Energy LLC and its affiliates (collectively, the “debtors”) were once one of the largest oil and gas exploration and production companies operating in the Gulf of Mexico. Faced with declining oil prices, the COVID-19 pandemic, and billions of dollars of decommissioning and environmental remediation obligations, the debtors filed for chapter 11 protection in August 2020 in the Southern District of Texas.

The debtors proposed a chapter 11 plan providing for: (i) a credit bid sale of some of their oil and gas assets and equity interests for approximately $1.03 billion; (ii) “divisive mergers” of the debtors after the completion of the credit bid sale, with the allocation of some oil and gas assets among the resulting entities; and (iii) the abandonment of other oil and gas assets in accordance with agreements reached with various U.S. government agencies. The government agencies agreed not to object to the plan on environmental grounds because it provided for an increased allocation of responsibility for the remediation and decommissioning liabilities.

Certain sureties objected to the plan because the credit bid sale and the allocation of assets to the newly formed entities were to be “free and clear” of all liens, claims, encumbrances, and other interests, including the sureties’ subrogation rights against the debtors, pursuant to section 363(f) of the Bankruptcy Code. The bankruptcy court confirmed the plan over their objections.

The bankruptcy court denied the sureties’ request for a stay pending appeal of the confirmation order. The chapter 11 plan became effective on August 27, 2021, and was substantially consummated shortly afterward.

On appeal to the district court, the sureties sought reversal only of the plan provisions dealing with the sale of the debtors’ assets free and clear of their subrogation rights. They argued that the relevant provisions in the confirmation order were ambiguous, incongruous, and contradictory. They also claimed that the bankruptcy court exceeded its authority in stripping them of their subrogation rights.

Instead of ruling on the merits, the district court ruled that the appeal was statutorily moot under section 363(m) because the sureties had not obtained a stay pending appeal, and equitably moot because, among other things, the relief requested by the sureties would be a “grave threat” to the success of the plan given the governmental agencies’ right to “veto” the plan on environmental grounds. See In re Fieldwood Energy III LLC, 2023 WL 2402871, at *5 (S.D. Tex. Mar. 7, 2023), aff’d, 93 F.4th 817 (5th Cir. 2024). The sureties appealed to the Fifth Circuit.

The Fifth Circuit’s Ruling

A three-judge panel of the Fifth Circuit affirmed the district court’s decision.

In so ruling, the Fifth Circuit addressed only the district court’s statutory mootness analysis. It declined to reach the district court’s alternative holding that the appeal was equitably moot.

Writing for the Fifth Circuit panel, U.S. Circuit Court Judge Leslie H. Southwick rejected the sureties’ arguments that: (i) the Supreme Court’s decision in Transform Holdco “has changed how we should understand Section 363(m)”; (ii) the district court erred in treating section 363(m) as jurisdictional; (iii) Section 363(m) does not apply because the sureties sought (albeit did not obtain) a stay pending appeal; and (iv) Section 363(m) is inapplicable because the plan confirmation order provisions they challenged were not integral to the sale of the debtors’ assets.

According to Judge Southwick, Transform Holdco did not “narrow[] the effect of Section 363(m) other than to clarify that a party can lose the benefit of its terms” by waiver or forfeiture, neither of which occurred in this case. Therefore, Judge Southwick wrote, “compliance with Section 363(m) was “important and mandatory.” Fieldwood Energy, 293 F.4th at 823 (internal quotations omitted).

The Fifth Circuit panel acknowledged that Transform Holdco discussed mootness outside the context of statutory or equitable mootness. However, Judge Southwick explained, the Supreme Court did so in rejecting the assignee/purchaser’s argument that the appeal of the bankruptcy court’s order approving the sale and lease assignment was constitutionally moot because the lease was no longer part of the bankruptcy estate. He further noted that the Court did not resolve that issue because the lower courts did not consider it. “The only mootness issue for us,” Judge Southwick wrote, “is that which arises under Section 363(m),” a determination unaffected by the Supreme Court’s discussion of constitutional mootness in Transform Holdco. Id.

The Fifth Circuit panel concluded that the district court “appropriately treated Section 363(m) as a nonjurisdictional precondition to relief that prevented the Sureties from succeeding on appeal.” Judge Southwick noted that the district court proceeded to discuss equitable mootness after finding that the appeal was statutorily moot under section 363(m). The fact that it did so, he explained, is evidence that the district court did not view section 363(m) as jurisdictional because, had that been the case, the court would have immediately dismissed the case for lack of jurisdiction without considering equitable mootness. Id.

According to the Fifth Circuit, the fact that the sureties sought a stay pending appeal was not relevant. The express language of section 363(m), Judge Southwick explained, requires that a stay have been granted. “There is no exception within the text,” he wrote, “for a party who seeks a stay and fails.” Id. at 824.

Finally, the Fifth Circuit concluded that the lower courts correctly found that the “free and clear” provisions in the chapter 11 plan challenged by the sureties were “integral to the sale.” The panel found no clear error in the bankruptcy court’s finding that “the deal is unlikely to close if we change it, modify our order, and that the cost would be approximately $350 million to the estate.” Id. at 825 (internal quotations omitted). The Fifth Circuit also cited testimony from a representative of the purchaser of the debtors’ assets that buying the assets free and clear was of “paramount importance,” including any claims based on subrogation rights. Id.

Outlook

As noted by the Fifth Circuit panel in Fieldwood Energy, section 363(m) of the Bankruptcy Code is “alive and well,” and the Supreme Court’s decision in Transform Holdco did nothing to change how the provision is to be applied. The Fifth Circuit’s ruling reinforces the importance of section 363(m) in promoting the finality of bankruptcy assets sales and fulfilling the reasonable expectations of debtors, creditors, purchasers, and other stakeholders. It also indicates that, at least in the Fifth Circuit, section 363(m) bars an appeal of an unstayed order approving a bankruptcy sale if the challenge relates to “an integral part” of the sale transaction.

Insights by Jones Day should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our discretion. To request permission to reprint or reuse any of our Insights, please use our “Contact Us” form, which can be found on our website at www.jonesday.com. This Insight is not intended to create, and neither publication nor receipt of it constitutes, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of the Firm.

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Jones Day – T. Daniel Reynolds (Dan)

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Fifth Circuit: Preference Claims Are Property of the Bankruptcy Estate that Can Be Sold

May 30 2024

A debtor’s non-exempt assets (and even the debtor’s entire business) are commonly sold during the course of a bankruptcy case by the trustee or a chapter 11 debtor-in-possession (“DIP”) as a means of augmenting the bankruptcy estate for the benefit of stakeholders or to fund distributions under, or implement, a chapter 11, 12, or 13 plan. However, it is less well understood that causes of action that become part of the bankruptcy estate in connection with a bankruptcy case (e.g., fraudulent transfer, preference, or other litigation claims) may also be sold or assigned by a trustee or DIP during bankruptcy to generate value. The U.S. Court of Appeals for the Fifth Circuit considered this question in Matter of South Coast Supply Co., 91 F.4th 376 (5th Cir. 2024). The court of appeals joined the Eighth and Ninth Circuits in concluding that avoidance actions (in this case, a preference claim) are property of the estate that can be sold to creditors as a means of generating value.

Broad Scope of Property of the Estate

When a debtor files a bankruptcy petition, the filing creates an “estate” that consists of, among other things, “all legal or equitable interests of the debtor in property as of the commencement of the case” (with certain exceptions) as well as all property that the estate acquires “after the commencement of the case.” 11 U.S.C. § 541(a)(1) and (a)(7). Also included in “property of the estate” is “[a]ny interest in property that the trustee [or DIP] recovers” under various provisions of the Bankruptcy Code (see 11 U.S.C. § 541(a)(3)), including section 550, which authorizes the trustee or DIP to recover any property (or its value) that has been fraudulently or preferentially transferred by the debtor during a specified period prior to its bankruptcy filing. The estate also includes any property interest that a bankruptcy court orders to be transferred to the estate or preserved for the estate’s benefit because it is either a lien securing an equitably subordinated claim (see 11 U.S.C. § 510(c)) or an avoided transfer (see 11 U.S.C. § 551). In addition, under section 541(a)(6) of the Bankruptcy Code, estate property includes any “[p]roceeds, product, offspring, rents, or profits of or from property of the estate,” with certain exceptions.

Section 541 “is intended to include in the estate any property made available to the estate by other provisions of the Bankruptcy Code.” City of Chicago, Illinois v. Fulton, 141 S. Ct. 585, 589 (2021). Carefully defining the scope of estate property in a given case may be critical to the outcome of the bankruptcy. Property of the estate is protected (with certain exceptions) by the automatic stay under section 362; it may generally be sold, used, or leased under section 363, and, if unencumbered or non-exempt, it is generally available to stakeholders for distribution under a chapter 9, 11, 12, or 13 plan.

Given the importance of estate property, courts have found that a wide variety of interests of the debtor qualify as property of the estate. See United States v. Whiting Pools, Inc., 462 U.S. 198, 204 (1983) (“Both the congressional goal of encouraging reorganizations and Congress’ choice of methods to protect secured creditors suggest that Congress intended a broad range of property to be included in the estate.”); see, e.g., ACandS, Inc. v. Travelers Cas. & Sur. Co., 435 F.3d 252 (3d Cir. 2006) (insurance policies were estate property); Whetzal v. Alderson, 32 F.3d 1302 (8th Cir. 1994) (causes of action); Windstream Holdings, Inc. v. Charter Commc’ns Inc. (In re Windstream Holdings, Inc.), 634 F. Supp. 3d 99 (S.D.N.Y. Oct. 6, 2022) (customer contracts), appeal filed, No. 22-2891 (2d Cir. Nov. 3, 2022) (argument held on Sep. 7, 2023).

Avoidance Actions

An indispensable tool available to a bankruptcy trustee (or DIP, by operation of section 1107(a)) is the power to augment the estate by avoiding and recovering certain transfers or obligations incurred by the debtor prior to filing for bankruptcy that either are fraudulent or unfairly prefer certain creditors. With respect to the former of these categories, section 548 of the Bankruptcy Code provides in part that the trustee “may avoid any transfer … of an interest of the debtor in property, or any obligation … incurred by the debtor, that was made or incurred within 2 years before the date of the filing of the petition.” 11 U.S.C. § 548(a)(1).

Fraudulent transfers that can be avoided include both: (i) actual fraudulent transfers, which are transfers made with “actual intent to hinder, delay, or defraud” creditors (see 11 U.S.C. § 548(a)(1)(A)); and (ii) constructive fraudulent transfers, which are “transactions that may be free of actual fraud, but which are deemed to diminish unfairly a debtor’s assets in derogation of creditors.” Collier on Bankruptcy (“Collier”) ¶ 548.05 (16th ed. 2023); 11 U.S.C. § 548(a)(1)(B).

A transfer is constructively fraudulent if the debtor received “less than a reasonably equivalent value in exchange for such transfer or obligation” and was, among other things, insolvent, undercapitalized, or unable to pay its debts as such debts matured. See Collier at ¶ 548.05; 11 U.S.C. § 548(a)(1)(B).

Fraudulent transfers may also be avoided by a trustee or DIP under section 544(b) of the Bankruptcy Code, which provides that, with certain exceptions, “the trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of [the Bankruptcy Code] or that is not allowable only under section 502(e) of [the Bankruptcy Code].” 11 U.S.C. § 544(b)(1). This provision permits a trustee to step into the shoes of a “triggering” unsecured creditor that could have sought avoidance of a transfer under applicable non-bankruptcy law (e.g., the Uniform Fraudulent Transfer Act or its successor, the Uniform Voidable Transactions Act, which has been enacted in many states). See generally Collier at ¶ 544.06. Section 544(b) is an important tool, principally because the reach-back period for avoidance of fraudulent transfers under state fraudulent transfer laws (or even non-bankruptcy federal laws, such as the Internal Revenue Code) is typically longer than the two-year period for avoidance under section 548. Id.

Section 547(b) of the Bankruptcy Code provides that, with certain exceptions, a trustee or DIP, “based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection (c),” may avoid “any transfer” made by an insolvent debtor within 90 days of a bankruptcy petition filing (or up to one year, if the transferee is an insider) to a creditor for or on account of an antecedent debt, if the creditor, by reason of the transfer, receives more than it would have received in a chapter 7 liquidation and the transfer had not been made. 11 U.S.C. § 547(b).

Section 547(c) sets forth nine defenses or exceptions to avoidance. These include, among other things, contemporaneous exchanges for new value, ordinary course of business transfers, transfers involving purchase-money security interests, and transfers after which the transferor subsequently provides new value to the debtor.

Unauthorized postpetition transfers of estate property may be avoided under section 549, and other provisions of the Bankruptcy Code authorize the trustee or DIP to avoid certain other kinds of transfers. See 11 U.S.C. § 545 (certain statutory liens); 11 U.S.C. § 553(b) (certain setoffs); 11 U.S.C. § 724(a) (avoidance of liens securing certain claims for damages, fines, penalties, and forfeitures).

If a transfer is avoided under any of these provisions, section 550 of the Bankruptcy Code authorizes the trustee or DIP to recover the property transferred or its value from the initial or subsequent transferees, with certain exceptions.

South Coast Supply

South Coast Supply Co. (“South Coast) is an industrial products distributor that began experiencing financial troubles in 2016. Needing extra cash, South Coast borrowed $800,000 from its then-CFO. Under the loan agreement, South Coast made 47 separate payments to its CFO totaling approximately $321,000. After resigning, the former CFO demanded that South Coast pay $405,261.87 to satisfy the outstanding balance of the loan. Then, in October 2017, South Coast filed a chapter 11 petition in the Southern District of Texas. Five months later, South Coast brought an avoidance action under section 547 of the Bankruptcy Code to avoid as preferential the $321,000 in prepetition payments it made to the former CFO.

South Coast’s sole secured lender was Briar Capital Working Fund Capital, L.L.C. (“Briar Capital”). After objecting to South Coast’s first proposed chapter 11 plan, Briar Capital settled its issues with South Coast and agreed to a second, modified plan. Under the modified plan, Briar Capital would abandon a security interest it held in the proceeds of a sale of certain “intangible assets” valued at $700,000. South Coast would then distribute the proceeds to unsecured creditors. Briar Capital also agreed to waive a claim that it asserted against South Coast for administrative expenses. In exchange, Briar Capital would receive South Coast’s interest in the pending avoidance action against the former CFO. The bankruptcy court approved the sale of the preference claim and confirmed the modified plan.

Briar Capital was substituted for South Coast in the preference action. With Briar Capital as the plaintiff, the adversary proceeding was withdrawn to the district court. The former CFO filed a motion to dismiss the complaint, arguing that Briar Capital lacked standing to prosecute the preference action. The district court agreed, holding that Briar Capital lacked standing to bring the preference claim against the former CFO because: (i) a successful recovery would not benefit South Coast’s estate, and (ii) Briar Capital was not a “representative of the estate” under section 1123(b)(3)(B) of the Bankruptcy Code, which states that a chapter 11 plan may provide for the “retention and enforcement” of any claim belonging to the estate “by the debtor, by the trustee, or by a representative of the estate appointed for such purpose.” Central to its decision, the district court noted an absence of explicit authorization in the Fifth Circuit for the sale of avoidance actions under section 547, as distinguished from avoidance actions under section 548, which the Fifth Circuit previously held could be sold in In re Moore, 608 F.3d 253 (5th Cir. 2010). Briar Capital appealed to the Fifth Circuit.

The Fifth Circuit’s Decision

In a three-judge panel, with U.S. Circuit Court Judge James L. Dennis penning its opinion, the Fifth Circuit reversed the district court. South Coast’s appeal, Judge Dennis wrote, turned on “whether preference claims—a type of avoidance action—may validly be sold.” South Coast Supply, 91 F.4th at 382.

The Fifth Circuit panel first considered whether a preference action qualifies as “property of the estate” under the broad, general definition found in section 541(a)(1) of the Bankruptcy Code. Quoting the Supreme Court’s broad holding that property of the estate “is intended to include in the estate any property made available to the estate by other provisions of the Bankruptcy Code,” the Fifth Circuit found that avoidance actions must qualify. Id. at 381–382 (citing Whiting Pools, 462 U.S. at 205). “Preference actions,” Judge Dennis explained, “are a mechanism in the Bankruptcy Code by which additional property is made available to the estate, fitting squarely within the Whiting Pools definition.” Id. at 382.

Next, the Fifth Circuit considered whether preference actions qualify as estate property under section 541(a)(7), which provides that property of the estate includes “any interest in property that the estate acquires after the commencement of the estate.” Guided by a previous Fifth Circuit decision, the panel found that section 541 was intended by Congress to be an “all-embracing definition” of “property of the estate” and that all “property interests created with or by property of the estate are themselves property of the estate.” Id. (quoting In re TMT Procurement Corp., 764 F.3d 512, 525 (5th Cir. 2014)). Therefore, the Fifth Circuit panel concluded, preference actions “clearly qualify” as property of the estate under section 541(a)(7). Id.

The Fifth Circuit panel cited similar holdings by the Eighth and Ninth Circuits. Id. at 383 (citing Pitman Farms v. ARKK Food Co. LLC (In re Simply Essentials LLC), 78 F.4th 1006, 1011 (8th Cir. 2023) (“Chapter 5 avoidance actions are property of the estate”); In re P.R.T.C., Inc., 177 F.3d 774, 780-81 (9th Cir. 1999) (“Although no provision of the bankruptcy code similarly authorizes others to exercise [the trustee’s] powers, ‘[i]t is a well-settled principle that avoidance powers may be assigned to someone other than the debtor or trustee pursuant to a plan of reorganization’ under 11 U.S.C. § 1123(b)(3)(B)”) (citation omitted); In re Prof’l Inv. Props. of Am., 955 F.2d 623, 625–26 (9th Cir. 1992) (ruling that a trustee’s strong-arm powers were transferable to a purchaser of the estate’s claim to proceeds from sale of property and noting that “[i]f a creditor is pursuing interests common to all creditors or is appointed for the purpose of enforcement of the plan, he may exercise the trustee’s avoidance powers”); In re Lahijani, 325 B.R. 282, 288 (9th Cir. BAP 2005) (“While there is some disagreement among courts about the exercise by others of the trustee’s bankruptcy-specific avoiding power causes of action, the Ninth Circuit permits such actions to be sold or transferred.”).

Judge Dennis commented that broad interpretations of “property of the estate,” now endorsed by three Circuits, best serve both the estate itself and its creditors. In this case, while “Briar Capital does not owe any percentage of the possible recovery in this case to the estate, its waiver of the right to collect administrative expenses and its release of its claim to $700,000 are concrete benefits to the estate.” Id. at 383.

The Fifth Circuit panel rejected the former CEO’s argument that, because “Briar Capital would be pursuing claims only for itself,” it “would be potentially allowed to recover more than rightfully due to it.” According to Judge Dennis, the court previously addressed this policy concern in Moore. Although Moore addressed the sale of fraudulent transfer rather than preference claims, Judge Dennis explained, “its underlying policy arguments apply with equal force in this case”—namely, that the sale of avoidance claims “will not necessarily undermine core bankruptcy principles,” and in approving such sales, “bankruptcy courts must ensure that fundamental bankruptcy policies of asset value maximization and equitable distribution are satisfied.” South Coast Supply, 91 F.4th at 383-84 (citing Moore, 608 F.3d at 262 n. 18) (internal quotation marks omitted). Moreover, he wrote, “[a]llowing the sale of preference actions will grant bankruptcy courts more flexibility in distributing assets, maximize the value of the bankruptcy estate, and in turn, allow for more equitable distribution of assets.” Id. at 384.

Judge Dennis further noted that allowing for the sale of preference claims as property of the estate may be the “most equitable option.” Id. This rule, he explained, allows for increased flexibility in distributing remaining assets and allows a trustee or DIP to maximize the bankruptcy estate. Id.

Finally, the Fifth Circuit panel rejected the argument by the former CFO that a party must be a “representative of the estate” to pursue a validly purchased preference claim. Id. at 384–385. According to Judge Dennis, “[w]hether Briar Capital is a ‘representative of the estate’ is irrelevant to this appeal.” Id. at 385. He explained that this conclusion is supported by: (i) section 1123(b)(3), which, as noted previously, states that a chapter 11 plan may provide for the “settlement or adjustment of any claim or interest belonging to the debtor or the estate” or “the retention or enforcement by the debtor, by the trustee, or by a representative of the estate appointed for such purpose of any such claim”; and (ii) the fact that section 363(b) of the Bankruptcy Code, which authorizes the use, sale, or lease of estate property outside the ordinary course of a debtors’ business, does not expressly require that the purchaser of estate property also be a representative of the estate, but only that the trustee provides notice of the sale and an opportunity for a hearing before the court. Id.

Outlook

There are a few key takeaways from the Fifth Circuit’s decision in South Coast Supply, First, when lawmakers enacted the Bankruptcy Code in 1978, they intended that the scope of “property of the estate” would be quite broad to ensure that all of a debtor’s assets could be administered in a bankruptcy case. Second, the expansive definition of “estate property” in section 541 of the Bankruptcy Code encompasses pre-bankruptcy causes of action belonging to the debtor as well as causes of action or claims that spring into existence on the petition date (e.g., avoidance causes of action under the Bankruptcy Code, including claims that a trustee or DIP can assert on behalf of creditors). Third, under appropriate circumstances, where the estate lacks sufficient resources to prosecute colorable claims or causes of action, the trustee or DIP can sell such claims or causes of action to generate value for the estate. The Fifth Circuit’s decision in South Coast Supply is therefore a positive development for bankruptcy trustees, DIPs, or other stakeholders seeking to maximize estate value.

Finally, with South Coast Supply, the Fifth Circuit joins the Eighth and Ninth Circuits in applying a broad and flexible definition of “property of the estate” to encompass avoidance actions (which the Fifth Circuit had previously considered only in the context of fraudulent transfer claims in Moore).

Jones Day – Julian E.L. Gale

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Should I Care That the Debtor Has Filed a Motion to Sell Its Assets?

May 30 2024
Sales pursuant to Section 363 of the Bankruptcy Code have become commonplace in bankruptcy cases as a mechanism to liquidate a debtor’s assets and maximize value for creditors. Selling the debtor’s assets to a third party provides a new go-forward business partner for the debtor’s vendors and customers, and likely provides continuity of jobs for the debtor’s former employees. Due to the benefits associated with a sale of the debtor’s assets, creditors or parties-in-interest may be under the misconception that they need not pay attention to the sale process. Discussed below are several key reasons that a party should pay attention to the debtor’s sale process to ensure that its rights are protected, and its goals achieved.

Key Issues

Protecting Executory Contract Rights. As part of a going-concern sale, the debtor often seeks to assume and assign its executory contracts to the purchaser. An executory contract can only be assumed and assigned if all monetary and nonmonetary defaults are cured. Contract counterparties will want to carefully review the sale papers to determine if their executory contract will be assumed by the purchaser. This is to confirm that they agree with the proposed cure amount (which is the amount required to cure any monetary default) and to timely file an objection if they do not. Additionally, contract counterparties will want to review the sale papers to understand how to obtain adequate assurance of future performance information from the proposed purchaser, since sometimes the bid procedures require contract counterparties to formally request such information. This financial information is important to ensure that the proposed purchaser is ready, willing, able, and has the financial wherewithal to perform under the terms of the contract. For additional information regarding executory contracts, cure claims, and adequate assurance of future performance, please see the following toolkit articles: (i) What Is an Executory Contract and What Will Happen to My Executory Contract in Bankruptcy?1 and (ii) What Is a Cure Claim and What Does It Mean That the Buyer Has to Provide Adequate Assurance of Future Performance Under My Contract?

Sale of Preference Claims. Section 547 of the Bankruptcy Code allows the debtor, subject to applicable defenses, to claw back funds paid to creditors within 90 days of the bankruptcy being filed (and such lookback period is extended to one year for insiders), claims which are referred to as preference claims. See How Can You Protect and Defend Your Business From Preference Actions?3 Preference claims constitute property of the debtor’s estate and as such the debtor can sell preference claims as part of a Section 363 sale. Purchasers often want to purchase preference actions to keep the debtor from pursuing their claims, which could alienate parties the purchaser intends to do business with going forward. Even though the purchaser is not the same entity as the debtor, a creditor may not fully understand the legal distinction between the two entities and may take adverse action against the purchaser should it be sued for a preference claim. This could lead to go-forward problems for the new owner. By purchasing preference actions, the purchaser eliminates this potential pitfall. To the extent that a party received payments in the 90-day preference period, understanding the terms of the sale (and the benefit of continuing to do business with the purchaser), might shield a party from having to defend against a preference claim.

Sale of Non-Estate Property. To the extent that the debtor is holding property belonging to the creditor, the creditor will want to ensure that the sale does not seek to sell such property to the purchaser. Section 363(m) of the Bankruptcy Code limits attacks on a sale order after the sale closes provided the purchaser acted in good faith and without notice of any adverse claims with respect to the assets. To the extent that a creditor has notice of the sale and does not timely act, there is a risk that Section 363(m) will ensure that the purchaser is able to take ownership of the creditor’s property.

Sales Free and Clear of Setoff Rights. Setoff rights of nondebtors are treated as secured claims in a bankruptcy case, and a sale motion may propose to sell assets to a buyer, including accounts receivable, free and clear of such rights. If a creditor that holds such setoff rights does not timely object, it could find itself obligated to the buyer for accounts receivable or other claims purchased by the buyer, but unable to assert its setoff rights against the buyer to reduce the amount owed.

Objecting to the Sale to Gain Leverage. Creditors have the right to file an objection both to the bid procedures as well as the terms of any proposed sale. Sometimes a creditor will want to file an objection to try to gain leverage in the bankruptcy case. An example of this occurs where the creditor does or does not want its contract assumed and is using the objection to try to achieve its desired outcome in the case. A party may also object to the sale to put pressure on the debtor to address issues of particular concern to it. By becoming the squeaky wheel, the debtor/purchaser may have an incentive to resolve the party’s issues in advance of approval of the sale. Of course, any objection a creditor might file must have a sound legal basis. Whether or not a creditor files an objection, it is important to understand that a debtor need only provide a legitimate business justification for the bankruptcy court to approve its sale.

Takeaway

A bankruptcy sale can affect a party’s rights, so it is important to monitor what is happening in the case and timely respond. Additionally, sometimes a party may want to object to the bid procedures or the underlying sale as a way to get the debtors’ attention in a case. As always, it is important to have experienced bankruptcy counsel to help a party navigate the complex bankruptcy issues that can arise in connection with a sale.

https://www.troutman.com/a/web/6oYw925JzEy8PMS6heuzYc/tp_creditors-rights-toolkit_debtor-has-filed-a-motion.pdf

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Successor Liability and Bankruptcy Sales: Can I Look to the Purchaser of My Customer’s Business for Payment of My Claim?

November 9 2023

Successor liability is a catchall term for a group of legal theories that, in certain circumstances, allow a creditor to recover amounts owed by its obligor from a person or entity who succeeds to the assets or business of that obligor. Typically, claimants cannot pursue successor liability against a purchaser in a bankruptcy sale because most sales are made “free and clear” of such claims under Section 363(f) of the Bankruptcy Code. However, there are some limited exceptions to this general rule.

Under Section 363(f) of the Bankruptcy Code, asset sales made in a bankruptcy case may be made “free and clear” of interests in the assets, including liens, claims, and encumbrances, under certain circumstances. The “free and clear” nature of these transactions is a defining feature of bankruptcy sales and a key motivator for buyers to purchase assets from a bankrupt company. Free and clear sales must meet at least one of the following conditions:

  1. Nonbankruptcy law permits the sale, “free and clear” of such interest;
  2. The holder(s) of such interest consent(s);
  3. The sale price exceeds the value of all liens on the property;
  4. Such interest is in bona fide dispute; and/or
  5. The holder(s) of such interest could be compelled to accept a money satisfaction of such interest.

Key Issues

  • Successor Liability. The majority of bankruptcy courts — although not all — have held that successor liability claims are “interests” of which assets can be sold “free and clear” under the Bankruptcy Code. Some courts have held that successor liability remains an issue determined by nonbankruptcy law and should not be impacted by the Bankruptcy Code, or have placed limits on the ability to sell assets “free and clear” of successor liability. Regardless of the approach a particular court takes, “free and clear” protection may not be effective against claimants who did not receive notice of the sale. Additionally, a purchaser may be unable to take assets “free and clear” of product liability claims and environmental claims that do not arise until after the sale closes.
  • Channeling Injunctions. In extreme circumstances, bankruptcy courts will issue a channeling injunction, whereby a claimant’s successor liability claims are channeled to a fund created, often from the proceeds of an asset sale, to satisfy such claims. In these cases, claimants can seek recourse from that recovery pool rather than attempt to bring a claim against a buyer.
  • Compliance With Bankruptcy Sale Orders. In courts that recognize the ability to sell assets “free and clear” of successor liability under the Bankruptcy Code, sale orders will often expressly enjoin the assertion of successor liability claims against the buyer or the assets being acquired. Even where a bankruptcy sale order is silent on the issue, though, a creditor contemplating pursuing a successor for the debts of a bankrupt obligor will want to ensure that its planned course of conduct does not violate the relevant sale order.

Takeaway

The intersection of bankruptcy law and successor liability is a complex issue, and the ability to seek recourse against a buyer who acquires assets pursuant to Section 363 will depend on the facts of the case and the precedent of the jurisdiction in which the bankruptcy is pending. In some cases, alternative recourse, such as a recovery pool created in relation to a bankruptcy court’s channeling injunction, may be available. If you have a potential successor liability claim against a buyer in a bankruptcy sale, it is important to have experienced bankruptcy counsel assess for the available recovery options.

Troutman Pepper – David M. Fournier, Evelyn J. Meltzer, Kenneth A. Listwak and Tori Lynn Remington
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Bankruptcy Trustees and Receivers Beware: The California Second District Court of Appeal Tests The Barton Doctrine’s Limits on Claims Against a Court-Appointed Officer Over a Distressed Commercial Real Estate Entity

October 26 2023

In Breanne Martin v. Leslie Gladstone, the Second District Court of Appeal recently decided a case that could reverberate throughout the receivership and bankruptcy industries. This case comes at a propitious moment as bankruptcy proceedings and receiverships – particularly for distressed commercial real estate entities – trend upward in California. Receivers and bankruptcy trustees alike should consider this case before operating a commercial real estate distressed entity.

The Doughertys’ Bankruptcy Proceeding

The case emerged from Christopher Dougherty and Nereida Dougherty’s Chapter 11 bankruptcy proceeding.[1]Their bankruptcy estate included their operating entity, JTA Real Estate Holdings, LLC (“JTA”), and JTA’s three properties, including one residential rental property located in Alpine, California (“Alpine Property”).[2] The bankruptcy court later converted the Doughertys’ bankruptcy case to Chapter 7 and appointed a Chapter 7 Trustee, Leslie Gladstone (“Trustee”).[3] Soon after her appointment, the Trustee sought the bankruptcy court’s consent to “Operate Business Pending Sale of Debtor’s Assets.”[4] Invoking its authority under 11 U.S.C. § 721, the bankruptcy court authorized the Trustee to operate JTA consistent with the orderly liquidation of the estate.[5] Under this authority, the Trustee could operate the Doughertys’ business assets, including the Alpine Property, until the Trustee liquidated the estate.[6] Three months after taking over the Doughertys’ business, the Trustee sought to abandon the Alpine Property because it was underwater and had “numerous” uncorrected code violations.[7] Shortly thereafter, the Trustee suffered a major setback: plaintiff Breanne Martin (“Martin”) sustained injuries at the Alpine Property before the Trustee abandoned it.[8]

Martin Sues the Trustee for Injuries She Incurred at the Alpine Property and the Trustee Seeks to Dismiss Martin’s Lawsuit

Martin sued the Trustee, asserting claims for negligence and premises liability.[9] The Trustee sought to dismiss Martin’s claims on two grounds. First, the Trustee argued that the Barton doctrine barred Martin’s claims because the bankruptcy court had not authorized her lawsuit.[10] Second, the Trustee contended that she was immune from Martin’s claims because she had abandoned the Alpine Property retroactively to the Doughterys’ bankruptcy filing date.[11] The trial court rejected the Trustee’s Barton doctrine defense but accepted the Trustee’s immunity defense from her abandonment of the Alpine Property.[12] The Martin Court reversed the trial court’s judgment.[13]

The Court of Appeal Reverses the Trial Court Judgment Against Martin

Considering the Trustee’s abandonment argument first, the Martin Court analyzed the transfers of a debtor’s property that occur during a debtor’s bankruptcy proceeding.[14] After a bankruptcy filing, the debtor’s legal and equitable interests in property become the property of the bankruptcy estate for creditors.[15] The debtor, however, may regain ownership and control over estate property during the bankruptcy case if the trustee abandons it.[16] After assessing these principles, the Martin Court focused on the impact of bankruptcy abandonment. As the Martin Court explained, “ownership and control of the asset is reinstated in the debtor with all rights and obligations before filing a petition in bankruptcy.”[17] Thus, the Martin Court conceived the key issue as the retroactive effect of the Trustee’s abandonment. The Trustee claimed the abandonment did more than just revert the Alpine Property to the Doughertys: It “operated as if the Doughertys retained … the Alpine Property, without interruption, throughout … the bankruptcy case.”[18] Although abandoned property reverts to the debtor from the petition date, the Martin Court refused to expand the bankruptcy abandonment rule as far as the Trustee urged.

The Martin Court recognized that retroactive abandonment is neither automatic nor absolute.[19] “Courts do not blindly give retroactive effective to a trustee’s abandonment of bankruptcy estate property in every situation.”[20]From this point, the Martin Court agreed with other bankruptcy courts that retroactive abandonment should occur only where justice requires it.[21] After searching nationwide, the Martin Court found no bankruptcy case where a court at the pleading stage applied abandonment retroactively to relieve a trustee of liability for injuries sustained on the bankruptcy estate property.[22] Comforted by this dearth of cases, the Martin Court declined to apply the legal fiction of relation back abandonment because it would have caused an unfair result – leaving Martin without a judicial remedy.[23] Retroactive abandonment also would have frustrated California’s policy of requiring those who exert control over property to ensure that such property remains reasonably safe.[24]Because Martin’s injuries occurred before the Trustee effectuated the abandonment, the Trustee was not absolved from liability for Martin’s injuries.

The Trustee implored the Martin Court to uphold the trial court’s dismissal anyway, citing the Supreme Court’s century-old Barton doctrine from Barton v. Barbour, 104 U.S. 126 (1881).[25] Under the Barton doctrine, an aggrieved party, before filing a lawsuit against a court-appointed officer, must obtain the appointing court’s consent.[26] The Barton doctrine safeguards trustees and receivers from “having to defend against suits by litigants disappointed by his actions on the court’s behalf, which would impede their work for the court.”[27] This vital protection for receivers and trustees is not limitless.[28] As the dissent in Barton acknowledged, the Bartondoctrine exceeds its purpose in cases where the court-appointed official does more than liquidate assets.[29]Congress, heeding this concern, precluded the Barton doctrine inqq situations where the court-appointed official continued the debtor’s business, rather than administered the estate.[30] Under 28 U.S.C. § 959(a), parties may sue “trustees, receivers, or managers of any property” for claims regarding “any of their acts or transactions in carrying on business connected with such property.”[31] Section 959 preserves the Barton doctrine for an aggrieved party’s claims against a trustee or receiver for actions consistent with preserving and liquidating the estate.[32] But if an aggrieved party challenges the trustee’s conduct in operating the debtor’s business, the aggrieved party need not obtain the appointing court’s consent to pursue such claims.[33]

Relying on bankruptcy cases nationwide limiting the Barton doctrine in similar scenarios, the Martin Court declined to apply it to Martin’s claims at the pleading stage.[34] Martin’s complaint alleged that the Trustee “owned, leased, occupied, maintained, or controlled” the Alpine Property as landlord during the relevant period.[35] The Trustee’s request to operate the Doughertys’ business and her monthly reports to the bankruptcy court supported this allegation.[36] Those documents showed that the Trustee was “carrying on an ongoing rental business connected with the premises” when Martin suffered her injuries.[37] Thus, the Martin Court concluded that Martin had sufficiently invoked § 959(a)’s exception to the Barton doctrine.[38]

Lessons from Martin

The Martin Court tried to protect Martin from a perceived Catch 22 – in which the debtor could not be liable because the accident happened post-petition and while the trustee owned and controlled the estate property, but the trustee could not be liable because she had “retroactively” abandoned the estate property. The Martin Court believed equity required it to apply § 959’s exception to the Barton doctrine and hold the Trustee responsible for Martin’s injuries. While Martin did not break new ground, it illuminates a risk that bankruptcy trustees and federal receivers take in operating a distressed commercial real estate entity. After Martin, an aggrieved party may now try to sue a court-appointed official (a bankruptcy trustee or a federal receiver) for injuries at a property owned and controlled by the court-appointed official. For the Martin Court’s attempts to protect the aggrieved party though, the opinion does not sweep as far as it may seem.

A bankruptcy trustee or a federal receiver faced with an aggrieved party’s lawsuit could try to distinguish Martinon its facts. The Martin Court seems to have overemphasized the effect of the Trustee’s decision to operate the Doughertys’ business. That decision, the Martin Court believed, unequivocally showed that the Trustee went beyond “the mere administration of property” and operated the Alpine Property like the Doughertys’ prebankruptcy. The decision though was consistent with the Trustee’s principal duty to “collect and reduce to money property of the estate ….”[39] The bankruptcy court authorized the Trustee to operate the Doughertys’ business for a limited time and consistent with an orderly liquidation. The Trustee undertook this task early to preserve the business assets while the Trustee sought to market them. That function should have been incidental to preserving the Doughterys’ business assets – a result that ordinarily should have triggered the Barton doctrine. The Martin Court did not hold that whenever a bankruptcy trustee seeks to temporarily operate a debtor’s business, the trustee automatically loses the Barton doctrine’s protection.

If the Barton doctrine does not apply when a bankruptcy trustee or a federal receiver operates a debtor’s business, both court-appointed officials still may be immune from an aggrieved party’s claims. The Martin Court did not address or purport to decide the Trustee’s potential immunity to Martin’s claims. Courts have long recognized that bankruptcy trustees enjoy immunity because they “perform an integral part of the judicial process.”[40] Federal receivers also have “absolute quasi-judicial immunity from damages.”[41] While judicial immunity does not encompass every kind of lawsuit that might be filed against a federal receiver or a bankruptcy trustee, judicial immunity should extend to damage claims, such as those in Martin, for acts within the court-appointed official’s duties.[42] Following Martin, federal receivers and bankruptcy trustees confronted with litigation for acts within the scope of their duties should raise the immunity protection “at the very earliest stage of the proceeding.”[43] As courts have acknowledged, for this protection “to be meaningful, it must be effective to prevent suits … from going beyond” the pleading stage.[44]

A California state court receiver, unlike a bankruptcy trustee or a federal receiver, might argue that Martinminimally impacts state court receiverships. Section 959’s exception to the Barton doctrine generally applies to bankruptcy trustees and federal receivers, not state court receivers.[45] California has no state corollary exception to § 959; in California, an aggrieved party must obtain the appointing trial court’s permission to sue a state court receiver in state court.[46] But a plaintiff’s failure to obtain leave is not jurisdictional and it may be cured at any stage of the proceedings.[47] Thus after Martin, a state court receiver that seeks to operate a debtor’s business should ensure that the appointing order acknowledges the receiver’s immunity for its work in operating the business and managing the debtor’s business assets. That language would bolster the receiver’s quasi-judicial immunity for acts within the receiver’s duties, and the receiver could use this immunity protection at the earliest stage of the aggrieved party’s action.[48]

To view all formatting for this article (eg, tables, footnotes), please access the original here.
Buchalter – Jarrett S. Osborne-Revis
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Did The Supreme Court Just Undermine Daimler? A Caution for Multistate Companies

USA June 28 2023

Hidden amidst the more high profile end of term decisions from the Supreme Court is a seemingly boring procedural decision that could have significant impact on businesses and expose them to litigation in a multiplicity of states where they never expected to be sued.

Nine years ago, in Daimler AG v. Bauman, 571 U.S. 117 (2014), the Court ruled that businesses are generally susceptible to suit only where they are incorporated and in their principal place of business. They are not subject to suit in a state on any matter merely because they happened to do some business there, including through a subsidiary. And businesses with a national distribution network therefore are not subject to suit anywhere their goods happen to end up. Id. 760-62.

In the new Mallory v. Norfolk Southern R. Co. decision, however, 600 U.S. ___ (Jun. 27, 2023), the Court dialed that back and held that Daimler should not be read so broadly. Instead, companies are also subject to suit in states where they are registered to do business if the registration statute of the particular state provides for a consent to jurisdiction. In that event, they are deemed present in the state just as a domestic company would be and can be sued for anything — contract, tort or otherwise — even if the lawsuit has no connection to any business the company transacted in the state.

Relying on the concept that consent has always been an exception to the old rule in International Shoe Co. v. Washington, 326 U.S. 210 (1945), that the Due Process clause protects against the unfairness of “haling” someone into court in another state with which it has few (if any) contacts, the Court held that the rule about personal jurisdiction being “specific” or “general” — which underpins Daimler — exists “side by side” a regime that continues to allow jurisdiction based on presence. And consent to jurisdiction under Pennsylvania’s registration to do business statute was held to be tantamount to physical presence since the statute says that an out of state business, once registered, is “deemed … located” in the state and treated the same as a local Pennsylvania business, and that once registered, state courts may “exercise general personal jurisdiction” over an out of state company. Norfolk Southern, slip op. at 10-11.

Of course, not all state foreign business registration statutes are written the same way, and Pennsylvania’s was particularly clear about registration constituting consent to jurisdiction. This made it easier for the Court to point to Norfolk Southern’s 20 years of registration-based consents and significant Pennsylvania operations as evidence that there was nothing unfair about making it litigate in Pennsylvania even in cases having no connection to the state. Id., slip op. at 17-20. But as the Court itself notes, some state business registration statutes are vaguer and just appoint the Secretary of State as agent for service of process, without saying for what types of cases they are appointed, or limit the jurisdictional consent to certain types of suits or certain types of companies. Id., slip op. at 6-7. The Court, relying on Pennsylvania Fire Inc. Co. v. Gold Issue Mining & Milling Co., 243 US. 93 (1917), nonetheless suggests that such a general appointment may well constitute a broad consent to jurisdiction. Norfolk Southern, slip op. at 8-9.

The Court’s decision in Norfolk Southern was limited to the question of whether holding an out of state company to jurisdiction in such circumstances violates the Due Process clause of the Constitution, and the Court held (5-4) that it does not. But the Court fractured — with four separate opinions — on what that means going forward.

Notably, Justice Alito’s concurrence highlights an argument not only for the Pennsylvania courts to consider on remand of Norfolk Southern, but also for businesses to use in other cases in an effort to narrow the impact of the Court’s ruling. Specifically, he noted that notwithstanding the purported consent, allowing states to mandate that companies must consent to all-purpose jurisdiction in their state as a condition of doing business may violate the Commerce Clause, either as discrimination against, or an undue burden on, interstate commerce. Concurring slip op. at 11-13. In that regard, he questioned what legitimate local purpose a state can have in seeking to exercise jurisdiction over companies based elsewhere when the claim has nothing to do with that forum state. And applied 50 times over, that would mean that every state can host litigation against companies that do business nationwide — the exact opposite of the result in Daimler — as long as their foreign business registration statute has some type of non-negotiable consent language, such that the commercial imperative of registering to do business in a state renders the company susceptible to all manner of lawsuits there.

As a practical matter, there is not much that many businesses can do about this conundrum. The commercial necessity of selling goods and services nationwide means that they may have no choice but to “consent” to broad jurisdiction in states that leave a company no option but to “consent” if they want to transact in the state. Whether a company with a sufficient appetite for litigation is willing to undertake a lengthy Commerce Clause challenge to such a regime in a later case has yet to be seen. For now, businesses need to be mindful that what was once perceived as a ministerial act of registering to do business in multiple states (and paying any required fees and taxes there) may now be a broad license to be sued in the courts of that state even in matters having nothing to do with the business transacted there.

Fried Frank Harris Shriver & Jacobson LLP – Peter L. Simmons, Michael C. Keats, Samuel P. Groner and Michael P. Sternheim

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In re Purdue Pharma L.P.: Second Circuit Reverses S.D.N.Y and Holds Bankruptcy Court Has Subject Matter Jurisdiction and Statutory Authority to Approve Sackler Family Releases

USA June 6 2023

On May 30, 2023, the United States Court of Appeals for the Second Circuit (the “Second Circuit” or the “Court”) rendered a much anticipated opinion (the “Opinion”),1 reversing the order of the United States District Court for the Southern District of New York (the “District Court”) that the Bankruptcy Code does not permit non-consensual third-party releases of direct claims and affirming the order of the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) confirming the chapter 11 plan (the “Purdue Plan”) of Purdue Pharma L.P. (“Purdue”), which approved non-consensual third-party releases of the owners of Purdue — members of the Sackler family.

The Opinion comes on the heels of a line of recent district court opinions upholding the propriety of non-consensual third-party releases in appropriate circumstances,2 a pending appeal before the Third Circuit Court of Appeals on the third-party releases approved in the Boy Scouts of America plan,3 and pending petitions for writ of certiorari in Highland Capital seeking review by the United States Supreme Court (the “Supreme Court”) of the scope of permissible plan exculpations, and whether Bankruptcy Code § 524(e) prohibits a chapter 11 plan from exculpating or releasing non-debtors for liability as held by the Fifth Circuit and consistent with rulings of the Ninth and Tenth Circuits.4

Background and Procedural History

On December 16, 2021, the District Court vacated the Bankruptcy Court’s order confirming the Purdue Plan, which had approved a mediated settlement that included non-debtor third-party releases for the Sacklers.5 For a detailed discussion on the background and procedural history of the Purdue bankruptcy case, see In re Purdue Pharma L.P.: S.D.N.Y. Holds Bankruptcy Court Lacks Statutory Authority to Approve Sackler Family Releases, VELaw.com (Dec. 28, 2021).

The Opinion

At issue before the Second Circuit was: (1) whether the Bankruptcy Court had the authority to approve the Purdue Plan’s non-consensual release of direct third-party claims against the non-debtor Sacklers; and (2) whether the Bankruptcy Code, the factual record, and equitable considerations supported the Bankruptcy Court’s approval of the Purdue Plan. The Second Circuit concluded that: (1) the Bankruptcy Court had “related-to” jurisdiction to approve the releases through submission of proposed findings of fact and conclusions of law to the District Court; (2) the Bankruptcy Court had the requisite statutory authority under §§ 105(a) and 1123(b)(6) to approve the releases; and (3) the factual record supported the Bankruptcy Court’s approval of the releases under a newly pronounced seven-factor test.

Subject Matter Jurisdiction: The Second Circuit first addressed whether the Bankruptcy Court had subject matter jurisdiction to approve the releases and found that it had “related-to” jurisdiction, but it lacked constitutional authority to approve the releases on a final basis. As such, the Second Circuit agreed with the District Court’s construction of the Bankruptcy Court decision as setting forth its proposed findings of fact and conclusions of law for the District Court’s de novo review.

Statutory Authority: Expressly joining the view of the majority of circuits, the Second Circuit explained that together, §§ 105(a)6 and 1123(b)(6)7 provide the statutory equitable authority necessary to permit the Bankruptcy Court’s approval of the Purdue Plan.8 The Second Circuit rejected the view of the minority of circuits that § 524(e)9 bars non-consensual third-party releases because they impermissibly discharge non-debtors.

The Second Circuit’s Test: The Second Circuit ruled that courts should consider the following seven factors:

whether there is an identity of interests between the debtors and released third parties, including indemnification relationships, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete the assets of the estate;
whether claims against the debtor and non-debtor are factually and legally intertwined, including whether the debtors and released parties share common defenses, insurance coverage, or levels of culpability;
whether the breadth of the release is necessary to the plan;
whether the release is essential to the reorganization, in that the debtor needs the claims to be settled in order for the res to be allocated (and not because the released party is somehow manipulating the process to its own advantage10);
whether the non-debtor contributed substantial assets to the reorganization;
whether the impacted class of creditors “overwhelmingly” voted in support of the plan;11 and
whether the plan provides for fair payment of enjoined claims, with a focus on the fairness of the payment and not the final amount of the payment.
Significantly, the Court explained that “[a]lthough consideration of each factor is required, it is not necessarily sufficient — there may even be cases in which all factors are present, but the inclusion of third-party releases in a plan of reorganization should not be approved.” Moreover, “[f]or the bankruptcy court to make such findings, extensive discovery into the facts surrounding the claims against the released parties will most often be required.”

Ultimately, the Second Circuit concluded that the Bankruptcy Court did not err by approving the Purdue Plan, and the Court identified the following findings, supported “in tens of millions of documents produced in discovery,” as relevant to that approval:

the identity of interests between the Debtors and those Sacklers named as defendants in the litigations;
the factual and legal overlap between claims against Debtor and settled third-party claims;
the releases being required to ensure that the valuation of the res is settled;
the scope of the releases was limited so that the released claims related only to the Debtor’s conduct and the estate;
the res itself amounted to only approximately $1.8 billion and, without the Purdue Plan, the government would recover its $2 billion first, which would deplete the res completely and prevent any recovery by other creditors;
the impact of the financial contribution of $5.5–0 billion is one of the largest contributions to a bankruptcy anywhere in the country; and
the valuation of claims (estimated at $40 trillion) far exceeds the total funds available and the Sackler’s wealth, which created the need for the Purdue Plan’s “intricate settlements.”
Summary of Key Takeaways

The Second Circuit’s Opinion further demonstrates the split among circuits as to the validity and permissibility of third-party releases in plans of reorganization. Notably, the Court’s requirement that a bankruptcy court submit proposed findings of fact and conclusions of law to a district court for its approval where third-party releases are included may delay the plan confirmation process in certain cases. The new seven-factor test could also prove burdensome for some plan proponents seeking non-consensual third-party releases as part of a global compromise, particularly in light of the Court’s emphasis on the need for extensive discovery and particularized factual findings to support the inclusion of third-party releases in a plan. In light of the circuit split, including the different approval standards among the permissive circuits, parties may continue to experience uncertainty in seeking third-party releases in a package that otherwise delivers a complete resolution. These issues may well ultimately be addressed by the Supreme Court (as practically invited by Judge Wesley in his concurring opinion) to resolve the circuit split and adopt a uniform approach.

Vinson & Elkins LLP – Katherine Drell Grissel, Kristie Torkildsen Duchesne, David S. Meyer, Steven M. Abramowitz, Bradley Foxman, Paul E. Heath, George R. Howard, Lauren R. Kanzer, Jessica C. Peet, William L. Wallander and Steven Zundell

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Grammar Dooms Innocent Spouse in Non-Dischargeability Case

THURSDAY, FEBRUARY 23, 2023

While we often recite that bankruptcy is for the honest but unfortunate debtor, a new case from the Supreme Court shows that getting into bed or business with the wrong person can lead to a non-dischargeable debt for an innocent spouse. The case is No. 21-908, Bartenwerfer v. Buckley, which you can find here.

What Happened

The case involved David Bartenwerfer and his then-girlfriend, later wife, Kate. They jointly bought a house to remodel in San Francisco.

Posted by Stephen W. Sather

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While we often recite that bankruptcy is for the honest but unfortunate debtor, a new case from the Supreme Court shows that getting into bed or business with the wrong person can lead to a non-dischargeable debt for an innocent spouse. The case is No. 21-908, Bartenwerfer v. Buckley, which you can find here.

What Happened
The case involved David Bartenwerfer and his then-girlfriend, later wife, Kate. They jointly bought a house to remodel in San Francisco. Their first mistake was that they apparently formed a general partnership to buy the property. Kate’s second mistake was leaving the construction and sale of the property to David. David failed to disclose defects in the construction which led to both of them getting sued and being hit with a judgment for over $200,000. When they filed bankruptcy, the judgment creditor brought a non-dischargeability case against them. The Bankruptcy Court found that David had committed fraud and that Kate was liable for David’s fraud due to their partnership. The Bankruptcy Appellate Panel found that Kate could not be held liable based on imputed intent. On remand, the Bankruptcy Court found that Kate did not have fraudulent intent. Unfortunately the Ninth Circuit reversed and reinstated liability against Kate.

The Court’s Ruling

A unanimous court ruled that non-dischargeability under 11 U.S.C. Sec. 523(a)(2)(A) is based on the type of debt, not the actions of the debtor. Here, the exception to being dischargeable turned on whether there was a debt for money “obtained by . . . fraud.” Supreme Grammarian Justice Amy Coney Barrett decreed that because the exception was written in the passive voice rather than the active voice that the debt was non-dischargeable. She stated:

The provision obviously applies to a debtor who was the fraudster. But sometimes a debtor is liable for fraud that she did not personally commit—for example, deceit practiced by a partner or an agent. We must decide whether the bar extends to this situation too. It does. Written in the passive voice, §523(a)(2)(A) turns on how the money was obtained, not who committed fraud to obtain it.
Opinion, p. 1. While the opinion goes on for twelve pages, everything a practitioner needs to know is on page 1. If someone obtained money through fraud and that person is liable for the debt, then the liability will not be dischargeable in bankruptcy.

What Does It Mean?

I have two thoughts about this case. The first is that it is so typical of the types of bankruptcy cases that the Supreme Court hears. This was a narrow, technical issue. We just don’t see the Supreme Court taking up the big issues of bankruptcy practice, such as equitable mootness or third party releases Instead, they take up these smallish cases that can be decided by looking at a small amount of statutory text.

The other way this decision is similar to other Supreme Court decisions on bankruptcy is that we don’t know whether this will have a big impact or a teeny tiny one. Justices Sotomayor and Jackson wrote a concurrence stating that they joined the opinion because “(t)he court here does not confront a situation involving fraud by a person bearing no agency or partnership relation to the debtor.” If the decision is limited to those parameters it will have a small impact because most people are savvy enough not to enter into a general partnership when an LLC can be formed for a few hundred dollars.

However, the concurrence may be trying to impose a limitation not present in the majority opinion. Justice “passive voice” Barrett did not place any limits on how a person might be liable on a debt for fraud. Yes, partnership and agency ensure that the person being held liable has a legal relationship to the person committing the bad acts, but is not the only way someone can be held liable for the debts of another. What is the most common way that someone can be held liable for someone else’s debt? By signing a guaranty. Assume a company has a CEO actively involved in the business and a financial partner. The firm takes out a bank loan guaranteed by the financial partner. Under Bartenwerfer, if the CEO lied to get the loan and the bank justifiably relied on those misrepresentations, a debt for money obtained by fraud is created. The innocent guarantor could be held liable just as the innocent girlfriend was in this case. If that is how the cases develop, then Bartenwerfer will have dramatically expanded the universe of debts that can be excluded from discharge.

View Full Blog Article Here:
https://stevesathersbankruptcynews.blogspot.com/2023/02/grammar-dooms-innocent-spouse-in-non.html

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