#LongDate#

I am writing this just after my return from the League’s Midwest Conference in Chicago. What I saw during those three days was a newly energized Bankruptcy Section. Energized in almost every respect.

Our educational programs drew hundreds of attendees and excellent reviews. People came to be educated and walked away with substantive knowledge applicable to their everyday practices.

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CASE ANALYSIS
Bankruptcy Court Creates Stringent Test for Payment to Critical Vendors

Catherine E. Vance, Esq.
Columbus, Ohio
Email: vance76@earthlink.net

Summary: When is it proper for a Chapter 11 debtor to pay the prepetition claims of unsecured creditors? In the well known Kmart bankruptcy, the court authorized payment of more than $180 million to vendors deemed critical to the company’s ability to successfully rehabilitate itself. In In re CoServ, LLC, 273 B.R. 487 (Bankr. N.D. Tex. 2002), the bankruptcy court carefully reviewed this issue, concluding that such payments may be authorized, but only in extraordinary cases.

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Attachment of Federal Tax Liens/Tenancy by the Entireties. Federal tax lien for husband’s tax liabilities attached to property held as tenancy by the entireties. Husband granted, under Michigan law, rights that qualify as property or rights to property to which federal tax lien attached. State law restricting ability of creditors to reach such property controls only insofar as state debtor/creditor relations are concerned, but does not bear on reach of federal tax lien statute. United States v. Craft, ____ U.S. ____, 122 S. Ct. 1414, 70 U.S.LW. 4249 (2002).

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SUA SPONTE

I am writing this just after my return from the League’s Midwest Conference in Chicago. What I saw during those three days was a newly energized Bankruptcy Section. Energized in almost every respect.

Our educational programs drew hundreds of attendees and excellent reviews. People came to be educated and walked away with substantive knowledge applicable to their everyday practices.

The Bankruptcy Section committees met and are moving ahead on numerous projects. The Newsletter Committee was commended for its overnight transformation of the Section Newsletter from a sleepy piece of mail to a high profile update on current law. Thanks are due to Alan Nahamias and Steven Solomon for their work, as well as to Sarah Jolie and Cathy Vance for this excellent effort. If anyone wishes to write for the newsletter, please contact either Alan Nahmias or Steven Solomon.

The Education Committee finalized its programs for the summer convention in Salt Lake City and its programs at the New York Eastern Regional Meeting. In New York, we will have a comprehensive advanced bankruptcy program, covering various cutting edge issues relating to corporate reorganizations. Our panel will be comprised of judges, academics and nationally renowned bankruptcy experts. In conjunction with the Young Members’ Section, we will also present a comprehensive basic bankruptcy program, addressing all issues, from filing to confirmation, from cash collateral to asset sales, from cram down to the automatic stay. If you need to be educated, New York is the place to be. Cathy Vance, the newly appointed League National Educational Coordinator, will be assisting in the development and implementation of this and all other League educational programming.

We have finalized the materials for solicitation of nominees of the Lawrence W. King Award, to be presented at the Eastern Regional Meeting in New York, and to be announced at the League breakfast at the National Conference of Bankruptcy Judges. If you know of someone who is worthy of this great honor, please contact Fredrick Luper or Judith Greenstone Miller with the nomination.

Speaking of NCBJ, under the continued chairmanship of the Hon. Frank Koger, we have lined up an exceptional panel of judges and noted bankruptcy experts to speak at the League’s afternoon educational program. Our breakfast speaker will William Brandt of Development Specialists, Inc., who will provide us with his unique, first hand insight into the legislative and political processes driving the bankruptcy reform process. I’m pleased to note that in addition to being a leading figure in our industry, Bill is also an active member of both the Section and our Executive Council.

The Bankruptcy Section’s coffers will be greatly expanded this year, based on the numerous sponsorships which already have been received and those which are being solicited for the NCBJ program. Sponsorship opportunities still remain, but are being taken quickly, so if you would like national recognition at the most prestigious bankruptcy conference of the year, now is the time to act. Simply contact the League office at 800-978-2552 or clla@clla.org.

We have had many applicants for the coveted positions on the Bankruptcy Section Executive Council. It has been many years since there has been such intense competition for Bankruptcy Section positions and of those wishing to get involved. We welcome the diversity which this expansion in involvement has brought to the Section and to the League as a whole.

The Legislative Committee has been hard at work as well. For those who have not noticed, the Conference Committee appointed to reconcile the House and Senate versions of the bankruptcy reform legislation met on April 23. In anticipation of that meeting, the Bankruptcy Section, on behalf of the League, developed numerous position papers which were delivered to the conferees as they walked into closed session. A lot of work was done in a very short period of time. Thanks go to our Legislative Committee co-chairs, Judith Greenstone Miller and Peter Califano, as well as to Cathy Vance, our legislative assistant. It appears that bankruptcy reform may be a reality this year. If so, the League, the Fund for Public Education and the Bankruptcy Section are poised to provide a nationwide educational program on the new legislation.

Bankruptcy Section participation is on the rise. Business is being handed out, commitments are being made and our profession is being furthered by your continued involvement. My tenure as Section President ends in just a few short months, but if the Chicago meeting was any indication of where we are headed, I know my successors will be very happy with the invigorated Bankruptcy Section which now is on the move.

Jay L. Welford
Jaffe, Raitt, Heuer & Weiss
One Woodward Avenue Suite 2400
Detroit, MI 48226
Phone: 313-961-8380 Fax: 313-961-8358
Email: jwelford@jafferaitt.com

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CASE ANALYSIS

Bankruptcy Court Creates Stringent Test for Payment to Critical Vendors

Summary: When is it proper for a Chapter 11 debtor to pay the prepetition claims of unsecured creditors? In the well known Kmart bankruptcy, the court authorized payment of more than $180 million to vendors deemed critical to the company’s ability to successfully rehabilitate itself. In In re CoServ, LLC, 273 B.R. 487 (Bankr. N.D. Tex. 2002), the bankruptcy court carefully reviewed this issue, concluding that such payments may be authorized, but only in extraordinary cases.

Facts: The Debtors, whose principal businesses consisted of providing telecommunications services, cable television, and website development and hosting, entered into a restructuring agreement with their Lender to sell their assets as a going concern. Their Chapter 11 cases were filed to effectuate the sale.

At a hearing on various first day pleadings, the Debtors requested authority to pay a number of prepetition claims owing to 27 unsecured creditors described by Debtors as “critical vendors.” The list was pared down to seven creditors after the court expressed concern with the nature and extent of the original request. As so modified, the Debtors’ request was unopposed.

Notably, the Unsecured Creditors Committee suggested that the list should be expanded to include additional vendors, some of whom served on the Committee. The court does not address this conflict of interest, perhaps because it was not before the court on the Debtors’ motion.

Issue: The court was concerned, first, with whether the Bankruptcy Code permits the payment of prepetition, unsecured claims of “critical vendors” and, if so, under what circumstances the court may authorize such payments.

Holding: The court held that the Bankruptcy Code does, in fact, permit a court to authorize the payment of prepetition, unsecured creditors’ claims, but because such payments contradict express provisions governing equal treatment of similarly situated creditors, they will be allowed only under where a three-pronged test, designed to show genuine necessity, is met.

Discussion: The threshold question for the court was whether the Bankruptcy Code authorized payment of prepetition, unsecured claims under any circumstance. As the court noted, no specific Code provision expressly authorizes such payment, and doing so runs contrary to express provisions dealing with unsecured claims.

The court nevertheless recognized that there are instances where payment of unsecured claims is essential to the continued viability of a reorganizing business, and found that the courts are empowered to deviate from the Code’s general treatment of unsecured claims when extraordinary circumstances so require.

The court rejected authority in other cases that payment of prepetition, unsecured claims is allowable under § 363(b)(1) (use of estate property in the ordinary course of business) or § 549 (power of court to reverse a postpetition transaction implies power to authorize such a transfer). Instead, the court found its power in § 105(a) and those provisions of the Bankruptcy Code that impose a fiduciary duty upon the debtor in possession. The court suggested a number of hypothetical examples of situations in which the debtor in possession, as a fiduciary, would be required to make payment on a prepetition claim in order to protect and preserve the bankruptcy estate, including the operation of the business to protect its going-concern value, for the benefit of all creditors.

The court found it necessary to develop a specific test to be used in determining when it is appropriate to pay the general unsecured debts of creditors in order to ensure their continued participation in a debtor’s business operations. The court considered a specifically articulated test to be necessary in light of the paucity of guidance given in the cases that had discussed the issue, as well as some degree of conflict in the circuits as to the allowability of critical vendor payments. The test is one of necessity involving three components, each of which must be shown.

First, it must be critical that the debtor deal with the claimant. As the court explained, the claimant must be “virtually indispensable to profitable operations or preservation of the estate.”

Second, unless the debtor deals with the claimant, the debtor risks the probability of harm or, alternatively, loss of economic advantage to the estate or to the debtor’s going concern value, which is disproportionate to the amount of the claimant’s prepetition claim. This requires a showing of a meaningful gain, or avoidance of serious economic harm. It further appears that a significant disparity between the amount of the prepetition claim and either the benefit gained or harm avoided must be present.

Third, there can be no practical or legal alternative by which the debtor can deal with the claimant other than by payment of the claim. The court referenced several options available to protect creditors and assuage their concerns about dealing with a business in bankruptcy. Among them are deposits, payment on delivery, letters of credit, and consignment of goods. The court also noted its power over such claimants. For example, a creditor that engages in “economic blackmail” in refusing to deal with the debtor absent payment of prepetition claims may have violated the automatic stay.

As applied to the specific claims at issue, the court granted the Debtors’ request as to only two creditors, and even these were limited. One claim came from a contract employee who, the court posited, would likely be paid in any event because his claim may constitute wages or contract assumption costs. The other involved services of a former employee of the Debtors with specialized knowledge from which the claimant derived no profit. In approving payment of this claim, the court required the claimant to continue under its existing arrangement with the Debtors for a fixed period, absent earlier termination by the Debtors.

With respect to the remaining claimants, the court found its own test was not met. Most provided goods or services that were available elsewhere, or the claimants could be protected through other means. Generally, through its application, the court set a tone that requires a significant showing of genuine necessity in order to obtain court approval of payment.

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CASE LAW UPDATE

Attachment of Federal Tax Liens/Tenancy by the Entireties. Federal tax lien for husband’s tax liabilities attached to property held as tenancy by the entireties. Husband granted, under Michigan law, rights that qualify as property or rights to property to which federal tax lien attached. State law restricting ability of creditors to reach such property controls only insofar as state debtor/creditor relations are concerned, but does not bear on reach of federal tax lien statute. United States v. Craft, ____ U.S. ____, 122 S. Ct. 1414, 70 U.S.LW. 4249 (2002).

Settlement of Disputes. Order dismissing debtor’s chapter 11 granted court continued jurisdiction to enforce and consummate settlement agreement related of dispute in which debtor did not participate. Debtor objected to settlement. Court held that jurisdiction to “enforce and consummate” also included power to approve or disapprove settlement; that debtor had standing to object to settlement despite not having participated in dispute; and that debtor’s agreement to court’s limited jurisdiction after dismissal did not amount to a waiver, nor warrant equitable estoppel, of debtor’s right to object. Fry’s Metals, Inc. v. Gibbons (In re RFE Indus., Inc.), 283 F.3d 159 (3d Cir. 2002).

Exceptions to Discharge. Noting split among circuits, court held settlement agreement in state court litigation alleging fraud and misrepresentation was novation substituting, in bankruptcy, a dischargeable contract claim in place of possibly nondischargeable tort claim. Archer v. Warner (In re Warner), 283 F.3d 230 (4th Cir. 2002).

Reciprocal Disbarment. Where a federal court seeks to impose reciprocal discipline on a member of its bar based on discipline imposed by another court or disciplinary authority, it is attorney’s burden to demonstrate by clear and convincing evidence that in prior proceeding there was a deprivation of due process or insufficient proof of misconduct, or that grave injustice would result from imposition of reciprocal discipline. In re Kramer, 282 F.2d 721 (9th Cir. 2002).

Dismissal of Case. Court had authority pursuant to § 105(a) to order chapter 13 debtor to file tax returns for all previous years in which no returns were filed; dismissal of case for debtor’s failure to comply was not abuse of discretion. Howard v. Lexington Invs., Inc. (In re Howard), 2002 U.S. App. LEXIS 5630 (1st Cir. April 2, 2002).

Set-Off/Fiduciary Duties. Corporate debtor may set off against shareholder’s claim where shareholder breached his fiduciary duty in failing to disclose corporate opportunity; that corporation could not have taken advantage of opportunity and shareholder did not personally profit are not persuasive because breach arises primarily from failure to present opportunity and disclose all material facts. Haseotes v. Cumberland Farms, Inc. (In re Cumberland Farms, Inc.), 2002 U.S. App. LEXIS 4998 (1st Cir. Mar. 27, 2002) aff’g Haseotes v. Cumberland Farms, Inc., 257 B.R. 691 (D. Mass. 2001).

Reaffirmation Agreements. Bankruptcy court found creditor violated automatic stay in conditioning reaffirmation of secured claim on reaffirmation of unrelated, unsecured debts owed creditor 253 B.R. 115 (Bankr. D. Me. 2000), and Bankruptcy Appellate Panel affirmed, 262 B.R. 159 (1st Cir. B.A.P. 2001). Court of Appeals reversed, holding creditor’s insistence is not a per se violation of the automatic stay. Reaffirmation agreements are inherently consensual and creditors may refuse to enter such agreements. Threats of foreclosure may amount to impermissible coercion, but here creditor acted lawfully. Jamo v. Katahdin Federal Credit Union (In re Jamo), 2002 U.S. App. LEXIS 4987 (1st Cir. March 26, 2002).

Denial of Discharge. Denial of discharge proper where debtors failed to maintain adequate records of their business transactions. That theirs was a personal bankruptcy did not excuse inadequacy of business records given extent and size of transactions. Debtors’ argument that equities of case, i.e., no showing of intent to defraud and over $15 million in debt, is a proper consideration, but did not amount to an abuse of discretion here. Union Planters Bank, N.A. v. Connors, 2002 U.S. App. LEXIS 4564 (7th Cir. March 21, 2002).

Equitable Redemption. Where bankruptcy is filed during period of equitable redemption, such period is not indefinitely extended pursuant to the § 362; rather, § 108 controls, requiring exercise of redemption right within 60 days after bankruptcy petition was filed. Canney v. Merchants Bank (In re Frazer), 2002 U.S. App. LEXIS 3663, 39 Bankr. Ct. Dec. 57 (2d Cir. March 7, 2002).

Catherine E. Vance, Esq.
Columbus, Ohio
614-890-0709
Email: vance76@earthlink.net

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Notice of General Membership Meeting and Bylaw Change Vote

The Bankruptcy Section will hold a general meeting of the membership on Saturday, July 13 at 8:00 a.m. to be held at the National Convention of the CLLA in Park City, Utah. At its recently concluded meeting of the Executive Council, the Section leadership has voted to recommend the following bylaw changes. Bylaw changes need membership approval, per the Bylaws of the Section. There will be a discussion of them during this General Membership Meeting and a vote.

Article VI, Item 13 to be changed as follows:

Upon completion of his/her term, the Immediate Past Chair of the Section shall serve as the Section's designee to the Board of Governors for a one year period. This period is to begin at the League's annual meeting immediately following the Section's annual meeting at which the Immediate Past Chair leaves the office. Said designee is not eligible to run in any other election while serving as a member of the Board of Governors. and for a period of one year after his or her term has concluded on the Board of Governors. If the Immediate Past Chair is unable to serve, the Executive Council shall appoint a replacement.

Comment: When the bylaws were changed in 1999 so that Council officers and board members would begin their term of office in July (previously service began in November), this provision was not adjusted. Due to the Nominating deadlines for National Office occurring in August, the current language necessitates that the Section’s Representative not run for National office within two National election cycles. The proposed language change allows the Representative to run for National Office upon completion of his/her term as Representative to the Board of Governors for the Bankruptcy Section. In addition, inserting the word “term” at the beginning of this Section is a grammatical correction.

Article IV, item 2 to be changed as follows:
The application shall state that the applicant is a lawyer member of the League.

Comment: This is a housekeeping change, as in 1999 non-lawyer members of the CLLA were admitted to membership in the Bankruptcy Section, per other bylaw changes.

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Washington Hot News
April 26, 2002
Schumer Amendment (Bankruptcy Bill) meeting.

The conferees on HR 333, the Bankruptcy Reform Bill, will meet again April 30th to discuss Sen. Schumer's (D-NY) amendment regarding the nondischargability of debts incurred as a result of violence targeted at abortion clinics. This provision is the only remaining controversial provision (the last hurdle) before the bill emerges from conference.

Schumer has been quoted as being willing to look at language but will not back down on the original premise of the amendment. One of the big "unknowns" is whether Sen. Biden (D-De), considered by many to be the swing vote on the conference due to his party affiliation being with the majority in the Senate but a willingness to side with the minority on other issues, will support Schumer. Schumer's staff has indicated they feel Biden will support them.

Interestingly, the amendment in question has already been watered down. As originally passed, the amendment specifically addressed anti-abortionists and clinic protests. However, after a drawn out negotiation with Sen. Hatch (R-Utah), Schumer agreed to expand the amendment to include all debts resulting from violations of law hindering the providing of lawful goods and services (avoiding even mentioning "abortion"). Despite this change, Republicans have continued to oppose the measure; apparently due to its genesis.

MORE WASHINGTON HOT NEWS

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©2002, Commercial Law League of America