Bankruptcy Litigation

Public Policy Necessitates Penetration of § 363’s Liability Shield

By: Julie Lavoie

St. John’s Law Student

American Bankruptcy Institute Law Review Staffer

In In re Motors Liquidation Co., the Second Circuit reversed the Bankruptcy Court of the Southern District of New York’s holding that the “free and clear” provision in the sale order barred plaintiff’s claims against New GM arising out of ignition switch defects. The Second Circuit acknowledged that the bankruptcy court was correct in concluding that even though the cars were not recalled for ignition switch defects until 2014, five years after the § 363 sale, there was ample evidence that Old GM knew or should have known about the ignition switch defect prior to bankruptcy. Therefore, due process dictates that claimants were entitled to notice of the sale by direct mail or an equivalent means. Unlike the bankruptcy court, the Second Circuit found that ignition switch claimants were prejudiced by this lack of notice. The Second Circuit could not confidently say that, given the circumstances, the outcome of the § 363 sale motion would have been the same if the claimants were notified and thus afforded the opportunity to be heard and partake in the negotiation.

Finding a Safe Harbor After the Storm

By: William Accordino

St. John’s Law Student

American Bankruptcy Institute Law Review Staffer

In In re Lehman Brothers Holdings Inc. (“Lehman”), Judge Shelley C. Chapman of the United States Bankruptcy Court for the Southern District of New York dismissed a complaint filed by Lehman Brothers Holding Inc. (“LBHI”) and Lehman Brothers Special Financing Inc. (“LBSF”) challenging the early termination of forty-four credit default swap agreements.[1] The complaint alleged the subsequent liquidation of the collateral underlying those agreements after the early termination and the distribution of those proceeds violated the Bankruptcy Code (“Code”) despite LBSF’s default.[2] Of the forty-four swap agreements, the court found five contained provisions that “effected an ipso facto modification of LBSF’s rights . . . .”[3] However, the distributions from those transactions were protected by the Code’s safe harbor provision.[4] Judge Chapman found the priority provisions in the other thirty-nine swap agreements did not operate as ipso facto clauses because they did not modify any rights of LBSF.[5] The payment priority for those agreements was not set at any time prior to the termination of the swap, thus no right to payment priority could be modified by a termination.[6] As a result, all nineteen counts of the complaint were dismissed for failure to state a cause of action.[7]

Exposing the Lack of Uniformity in U.S. Bankruptcy Law: Puerto Rico’s Own Municipal Bankruptcy Law Preempted by Chapter 9

By: Matthew Repetto

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Franklin v. Puerto Rico , the First Circuit held that Puerto Rico’s effort to restructure the debt of its public utilities through the enactment of its own municipal bankruptcy law, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (“Recovery Act”), was preempted by Section 903(1) of the United States Bankruptcy Code.[1] Amid the most serious fiscal crisis in its history, Puerto Rico’s public utilities are currently at risk of becoming insolvent.[2] Unlike states, Puerto Rico is a territory and “may not authorize its municipalities . . . to seek federal bankruptcy relief under chapter 9 of the U.S. Bankruptcy Code.”[3] Thus, the Recovery Act was Puerto Rico’s attempt to “fill the gap” by providing relief on its own.[4] The Recovery Act was enacted to mirror chapter 9 and chapter 11 of the United States Bankruptcy Code.[5] Those in favor of the Recovery Act argued that preemption would leave Puerto Rico with no means of relief.[6] However, the First Circuit disagreed, and noted that Puerto Rico could, as it had already, seek relief directly from Congress.[7]

Discretionary Automatic Stays “Pave” Way for More Litigation

By: Joanna Matuza

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Pavers & Road Builders District Council Welfare Fund v. Core Contracting of NY, LLC, the Eastern District Court of New York exercised its discretion with regard to automatic stays in its holding that a corporation’s alter ego status does not permit an automatic stay for non-debtors. In Pavers & Road Builders District Council Welfare Fund, administrators of an Employee Retirement Income Security Act (“ERISA”) pension fund brought suit against four related corporate defendants for “delinquent contributions and shifting of assets to avoid having to pay workers.” Canal Asphalt, the defendant-debtor, filed a voluntary petition for chapter 11 relief in the Southern District of New York. Thus, the cause of action was automatically stayed against the debtor, pursuant to section 362(a)(1) of the Bankruptcy Code. The other defendants argued in a letter to the District Court of Eastern District of New York that because they are alter egos of one another, the automatic stay arising in the debtor’s case should prevent the action from proceeding against all defendants. The Eastern District court disagreed, and instead, issued an order stating that the automatic stay only enjoined actions against debtors or their property.

Third Circuit Finds Limited Partners’ “Direct” Claims to be Masked Derivative Ones

By: Kristen Lasak

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re SemCrude L.P., the U.S Court of Appeals for the Third Circuit found that the claims of breach of fiduciary duty, negligent misrepresentation, and fraud set forth by limited partners against the co-founder and former President and CEO of SemCrude L.P. were derivative of the claims held by SemCrude’s Litigation Trust. SemCrude L.P. is an Oklahoma-based oil and gas company co-founded by Thomas Kivisto, who allegedly drove the company into bankruptcy due to self-dealing and speculative trading strategies. In July 2008, SemCrude, along with its parent company and certain subsidiaries, filed petitions for relief under chapter 11 with the United States Bankruptcy Court for the District of Delaware. On October 28, 2009, the bankruptcy court issued an order confirming SemCrude’s plan of reorganization, which established a Litigation Trust. The plan specifically transferred the claims belonging to SemCrude’s bankruptcy estate to the Litigation Trust and authorized the Litigation Trust to pursue SemCrude’s claims and distribute any money attained to SemCrude’s creditors. The Litigation Trust asserted thirty claims, including breach of fiduciary duty, breach of contract, fraudulent transfer, and unjust enrichment, against Kivisto and certain Semcrude officers. On November 19, 2010, the bankruptcy court approved a $30 million settlement agreement, which also incorporated a mutual release of all claims. Particularly, the Litigation Trust released Kivisto and the other officers from being accountable to any party for “contribution or indemnity relating to the released claims.”

A Showing of Gross Recklessness Satisfies Section 523(a)(2)(A): Denying Deceivers the Ability to Discharge Debts Related to Fraudulently Obtained Funds

By: Megan Kuzniewski

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

11 U.S.C. Section 523 lists certain debts that may not be discharged by a debtor’s bankruptcy.[1] In particular, 11 U.S.C. Section 523(a)(2)(A) (“Section 523(a)(2)(A)”) provides that a debtor who files a bankruptcy will not be discharged of debts that were obtained by “false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.”[2] False representations, such as those described in Section 523(a)(2)(A), carry a scienter requirement which requires that it be shown that an individual knowingly made false statements or representations.[3] In In re Bocchino , the Court of Appeals for the Third Circuit found that gross recklessness satisfies the scienter requirement of Section 523(a)(2)(A).[4] In S.E.C. v. Bocchino , the Securities and Exchange Commission (the “SEC”) filed a lawsuit against Bocchino, a stockbroker, in the District Court of the Southern District of New York.[5] The district court found Bocchino civilly liable for “inducing investors via high pressure sales tactics and material misrepresentations” and entered a judgment against him totaling $178,967.55, including disgorgement of fees, interest, and civil penalties.[6] Thereafter, Bocchino filed for chapter 13 bankruptcy protection.[7] The SEC petitioned the bankruptcy court for a judgment declaring the judgments against Bocchino nondischargeable under Section 523(a)(2)(A).[8] The SEC argued that Bocchino had obtained the funds “by… false pretenses, a false representation, or actual fraud.”[9] Bocchino had sought investors for two ventures that turned out to be fraudulent.[10] He began seeking out investments without doing any independent research into the ventures, despite there being cause for suspicion.[11] The bankruptcy court found that, although “Bocchino did not knowingly make any false statements,” the scienter requirement of Section 523(a)(2)(A) “may be satisfied by grossly reckless behavior.”[12] The bankruptcy court discharged the civil penalty portion of the judgment but concluded that the remaining portions of the judgment were nondischargeable under Section 523(a)(2)(A).[13] Bocchino appealed this finding.[13] On appeal, the district court affirmed the bankruptcy court’s decision,[15] and thereafter, the Third Circuit also affirmed the lower court.[16]

Bankruptcy Court Enforced 20-Year Old Orders Barring Asbestos Claims Against Insurance Company

By: Amanda Hoffman

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Johns-Manville Corporation, the United States Bankruptcy Court for the Southern District of New York enforced orders it issued in 1986, confirming a plan (the “Plan”) of reorganization for Johns-Manville. Pursuant to the Plan, a settlement agreement was reached in which insurers contributed $770 million to a trust benefitting asbestos personal injury claimants. In exchange, the insurers of Johns-Manville, including long-time insurer Marsh USA (“Marsh”), were relieved of all liability related to their insurance of Johns-Manville and the insurers would be protected from claims via injunctive orders of the Bankruptcy Court. Marsh contributed $29.75 million to the trust in exchange for the injunction, which barred future claimants from bringing action against Marsh as an insurer of Johns-Manville. This settlement agreement was approved by the court, resulting in the court entering a confirmation order of the Plan (the “Confirmation Order), and an Insurance Settlement Order, together known as the “1986 Orders”. Under the 1986 Orders, Johns-Manville and its insurers were released from further liability, but present and future claimants could claim against the trust. Part of the settlement agreement included the appointment of a legal representative by the Bankruptcy Court, in order to ensure the rights of future claimants.

The Resurrection of the Eleventh Amendment in Chapter 9 Cases

By: Christopher J. Pedraita

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Reversing the bankruptcy court, in In re City of San Bernardino, a district court recently held that the Eleventh Amendment barred a chapter 9 debtor’s claims against certain state agencies. In San Bernardino, the City of San Bernardino (the “City”) sought to protect funds, which the State of California (the “State”) demanded that the City remit to the State. The funds at issue in San Bernardino had been parceled out to the City’s redevelopment agency (“RDA”) and earmarked for redeveloping urban neighborhoods. In light of the fiscal emergency experienced by State in 2011, however, its legislature supplanted the existing RDAs with “successor agencies” to conclude all remaining matters of the RDAs, including returning the funds to the county auditor-controller that the RDAs had not already been committed to a project. As part of this process, the State ordered the City’ successor agency to return millions of dollars in tax revenues to the State’s Department of Finance (the “DOF”). If the successor agency failed to remit the funds to the DOF, the State warned that it could withhold tax revenue from the successor agency or the City. The warning prompted the City to commence adversary proceedings against the various state agencies seeking injunctive and declaratory relief to, among other things, prevent the State agencies from withholding tax revenue from the successor agency (and the City itself). The State agencies moved to dismiss the City’s complaint on several grounds, including that claims were barred under the Eleventh Amendment. While the bankruptcy court granted the State agencies’ motion to dismiss with leave to amend, believing that the City could show imminent injury if the state agencies withheld the tax money, the court rejected the state agencies’ Eleventh Amendment defense. In particular, the bankruptcy court ruled that when the subject of litigation was unquestionably within the court’s control state sovereign immunity could not prevent the adversary proceeding. On appeal, the district court reversed the bankruptcy court holding the Eleventh Amendment to apply in order to protect the State’s rights to run its own finances.

Judicial Estoppel: Essentially Locking a Litigation Trust into Representations Made During Prior Bankruptcy Proceedings

By: Sophie Tan

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in Adelphia Recovery Trust v. Goldman Sachs & Co., the Second Circuit held that a fraudulent conveyance claim brought by a litigation trust, created to recover assets for the benefit of unsecured creditors of Adelphia Communications Corp. (“ACC”), was barred by the doctrine of judicial estoppel because the funds at issue were transferred from an account that the plaintiff’s predecessor-in-interest scheduled as an asset of one of the predecessor’s subsidiaries, not the predecessor itself. The litigation trust commenced a fraudulent conveyance claim against Goldman, Sachs & Co. under sections 548(a)(1)(A) and 550(a) of the Bankruptcy Code to recover certain payments made to Goldman from a concentration account held in the name of Adelphia Cablevision Corp. (“Adelphia Cablevision”), a subsidiary of ACC. Goldman later moved for summary judgment on the grounds that (1) the plaintiff lacked standing to assert the fraudulent conveyance claim because the payments were not transfers of ACC's property; and (2) the plaintiff failed to raise a material issue of fact as to whether the payments were made with an actual intent to hinder, delay or defraud ACC's creditors. In response, the litigation trust argued that “ACC was the real owner of, and payor from, the Concentration Account” because ACC exercised complete control over the collective cash of ACC and its subsidiaries in the concentration account. While the district court recognized that the money in the concentration account may have been attributed to ACC prior to the bankruptcy proceedings, the district court ruled that “the easy attribution of money to whatever entity may at the moment be convenient stopped with the bankruptcies.” Therefore, the district court granted Goldman’s motion for summary judgment, stating that “it [wa]s admitted by [the litigation trust’s] own revised pleading that the margin loan payments were not made by ACC but by Adelphia Cablevision LLC, an ACC subsidiary on whose behalf [the litigation trust] does not have standing to sue.” The Second Circuit affirmed, holding that the litigation trust did not have standing to sue because it was judicially estopped from arguing now that ACC owned the account.

The Inapplicability of Section 922(d): Interest Rate Swap Agreements Do Not Qualify as Special Revenue Bonds

By: Debra March

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in Syncora Guarantee Inc. v. City of Detroit,[1] a federal district court held that the exception to the automatic stay contained in section 922(d) of the Bankruptcy Code did not apply to casino tax revenues pledged to secure the debtor’s swap obligations because the court opined that the swap agreements were not the type of special revenue bonds that the statute was intended to protect, and the debtor’s swap obligation was not a form of indebtedness owed to the swap counterparties or the swap insurer.[2] In 2005, the City of Detroit (the “City”), in order to strengthen its finances and secure pensions, issued debt by forming two not-for-profit service corporations to issue Certificates of Participation (“COPs”) since state law prohibited the City from directly issuing more debt.[3] These service corporations sold the certificates and gave the capital to the City to fund its pensions.[4] The City needed to protect itself against the risk of floating interest rates of COPs[5] because if the rates increased, the amount of interest the City would owe would also increase.[6] In order to protect the City against this risk, the service corporations executed interest-rate swaps with two banks.[7] Since the City had major debt problems, however, investors would not buy the COPs and the banks would not execute the interest-rate swaps without an insurer guaranteeing the City’s obligations.[8] Syncora, a monoline insurer, promised to make payments under the certificates and the swaps if the City failed to do so.[9] After the City defaulted, Syncora allowed the City to enter into a collateral agreement with swap counterparties.[10] Pursuant to this agreement, the City gave swap counterparties an optional termination right and created a “lockbox” system the caused casino tax revenues to be paid into a designated bank account, which could be frozen if the City failed to make it swap payments.[11] The swap counterparties could access this casino tax revenue by obtaining the City’s permission.[12] In June 2013, Syncora notified the bank that the City had defaulted, and the bank froze the casino tax revenues in the account.[13] The City sued in state court to recover the funds.[14] After the state court ordered the bank to release the funds, Syncora removed the case to the federal district court.[15] The district court then transferred the case to bankruptcy court after the City subsequently filed for bankruptcy in July 2013.[16] In August 2013, the bankruptcy court decided that the casino tax revenue was property of the estate and protected by the automatic stay.[17] In April 2014, the district court sua sponte stayed Syncora’s appeal of the bankruptcy court’s decision regarding the lock box funds until the Sixth Circuit ruled on whether the City was eligible to file.[18] Subsequently, the Sixth Circuit granted Syncora’s request for a writ of mandamus and directed the district court to rule on Syncora’s appeal.[19] Ultimately, the district court affirmed the bankruptcy court’s ruling.[20]

Bankruptcy Litigation

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