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April 2004 issue: Washington Hot News April 12, 2004 The Judicial Conference Advisory Committee on Rules of Bankruptcy Procedure Advisory Committee has scheduled a two-day meeting on September 9-10, 2004 from 8:30 am to 5 pm at the Ritz Carlton, Montara Room, One Miramontes Point Road, Half Moon Bay, California. The meeting will be open to public observation but not participation. Authors needed! The Bankruptcy Section Newsletter Committee is looking for volunteers to write a Case Analysis for an upcoming edition. The Case Analysis is typically based on Court of Appeals or Supreme Court decisions, although you can use your discretion to discuss relevant BAP, District Court and Bankruptcy Court decisions. If you are interested or would like to learn more, please send an email to the Managing Editor. You can view the archive at www.cllabankruptcy.org. (link email to sjolie@clla.org) Your subscription You have been subscribed to this list as part of your membership in the Bankruptcy Section of the Commercial Law League of America. Changes to your e-mail address and all other comments can be sent to Editor@cllabankruptcy.org CLLA 70 East Lake Street, Suite 630 Phone: 312-781-2000 Newsletter design by: |
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the online version can be found here: Sua SponteLouis S. Robin I’d like to break from writing about the usual and venture into a discussion of a recent decision that appears to have no immediate bankruptcy relevance. Still, it has unique import for those who practice in the bankruptcy forum. I refer to Justice Scalia’s recent memorandum in the Cheney v. United States District Court where Justice Scalia denied a motion to recuse. Case Analysis Richard E. Kruger SEVENTH CIRCUIT HOLDS KMART CRITICAL VENDOR ORDER INAPPROPRIATE Synopsis : Many people had high expectations when they heard that non-critical creditors appealed a “critical vendor order” entered in the Kmart bankruptcy proceedings to the Seventh Circuit Court of Appeals. Proponents and opponents of critical vendor orders hoped that the Seventh Circuit would clearly condone or condemn their use. However, the Seventh Circuit’s opinion of In re Kmart Corp., 359 F.3d 866 (7 th Cir. 2004), did not come close to meeting expectations. Case Law UpdatePaige Barr Debtor-In-Possession Permitted to Assume an Unexpired Lease Without First Curing Non-Monetary Defaults. Disagreeing with the Ninth Circuit, the First Circuit held that § 365(b)(2)(D) permits the debtor-in-possession to assume an unexpired lease without first curing non-monetary defaults. Court held that preventing a debtor from assuming a contract based on historical events that it could not remedy undermined Congress's basic purpose in § 365 to promote the successful rehabilitation of the business for the benefit of both the debtor and all its creditors. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Sua Sponte
Although there has been significant discussion in the press, some background is appropriate. One of the respondents, the Sierra Club, filed a motion to recuse on the basis that Justice Scalia’s December 2003 hunting trip with Vice President Cheney, to which both were transported on Air Force Two, raised serious questions about Justice Scalia’s impartiality. The Vice President, as is well known, has been sued by the Sierra Club and Judicial Watch, both of which seek information from the National Energy Policy Development Group which the Vice President chaired. Justice Scalia provides a thoughtful and, in my opinion, well reasoned decision. He notes that strict compliance with the recusal statute is required (which requires recusal only if “impartiality might reasonably be questioned”) rather than a standard of “resolv[ing] any doubts in favor of recusal” as argued by the movant. This is, in part, because recusal of a Supreme Court justice reduces the number of judges hearing the matter, while other courts can simply replace the recused person. Justice Scalia continues by attempting to clarify the facts as alleged in the motion. He had little, if any, contact with the Vice President during the trip. This hunting trip has been hosted by a friend of Justice Scalia for five years, and this was the first time the Vice President was invited. The Justice incurred the same travel cost even though he flew with the Vice President on his government flight (although there was admittedly some additional convenience). Additionally, Justice Scalia explained the Vice President’s role in the pending action as a minor one. Other facts were detailed by Justice Scalia in his effort to dispel many of the various allegations that were asserted in the press. Justice Scalia discussed the many relationships between past administrations and Supreme Court Justices. He reiterated stories of President Franklin Roosevelt’s poker parties with Justice Douglas, President Truman’s poker games with Chief Justice Vinson, and Attorney General Kennedy’s vacationing with Justice White. Other examples were provided. Justice Scalia concluded that there was nothing wrong with these instances. These Justices were only socializing with friends. Similarly, no one criticized these events at the time they arouse. Based on his analysis, Justice Scalia found that there was no basis to find that the trip could cause his impartiality to be reasonably questioned. Justice Scalia’s opinion is lengthy, well reasoned, and my attempt to summarize it is limited at best. I suggest to all that they read it here. Further. I do not doubt Justice Scalia’s impartiality, and I am confident that his (admitted) friendships will not affect his ultimate decision. It is difficult for me to question Justice Scalia’s reasoning. Nevertheless, upon a second reading, two serious questions were raised in my mind. True, Supreme Court Justices often have had friendships with Presidents and their administrations, but the question isn’t whether that justifies conduct today, but rather whether they were correct then. When judges are appointed, no matter what the court, a public trust has been placed in them. This requires sacrifice – which, when one considers the sacrifices made in today’s present overseas conflict (despite your political persuasion) and past conflicts, is truly minor. This does not mean that, once appointed, a judge must end all friendships and avoid all social contact. It is important for judges to maintain friendships, to participate in appropriate bar events, and be an active member of the community. These provide perspectives for both sides of the bench. Still, judges owe the public the appearance of impartiality and this requires ending some relationships. Although I agree with Justice Scalia’s observation that “[i] f it is reasonable to think that a Supreme Court Justice can be bought so cheap, the Nation is in deeper trouble than I had imagined,” this remark does not justify certain conduct. We should all remember the adage that “as important as it might be to do justice, it is more important to appear to do justice” (the later of which includes doing justice). Another concern originates from Justice Scalia’s comment that “[m]any Justices have reached this Court precisely because they were friends of the incumbent President or other senior officials—and from the earliest days down to modern times Justices have had close personal relationships with the President and other officers of the Executive.” This sends the wrong message to the countless number of attorneys who have humble beginnings, who work hard at their craft, and display intellect and skill in their profession. It says to them that they need not consider appointment to a judgeship because “friendship,” rather than intellect or hard work, is the decisive factor. It is also an affront to the many selection panels that have toiled seriously, objectively, and effectively in the decision process. True, having some familiarity with a candidate for a judicial appointment is necessary, but this should not be the “precise” factor. I now turn to the relevance to the average bankruptcy practitioner. We are all concerned with public perception of bankruptcy. Even though the charge of a “bankruptcy ring” is many decades old, the relatively small bar, the tendency for settlement due to the preceding and other reasons, and the mere subject of bankruptcy, means we are all sensitive to public perceptions. Still, we all toil diligently, appreciating the heightened scrutiny and keenly accepting our unique commitment. Similarly, Bankruptcy Judges take great care in their relationships with attorneys and the public. They understand that the perception of the Bankruptcy Court is diminished if certain relationships are maintained. They recognize the sacrifice that is necessary, and feel privileged that they must make it. Selection committees make their decisions based upon the most objective criteria, committing significant time and effort to their endeavor. I am proud of all who take their responsibilities so seriously. Again, I do not question Justice Scalia’s impartiality – Vice President’s Cheney’s joining this hunting trip, at least in my opinion, will not affect Justice Scalia’s ultimate decision. I consider Justice Scalia beyond reproach, and, in my mind, his intensity and intellect cannot be questioned. Further, his rationale is well reasoned, articulate, and worth reading. Still, at least upon my second reading, I find questions raised that I believe should be addressed. Louis S. Robin Case AnalysisSEVENTH CIRCUIT HOLDS KMART CRITICAL VENDOR ORDER INAPPROPRIATE Synopsis : Many people had high expectations when they heard that non-critical creditors appealed a “critical vendor order” entered in the Kmart bankruptcy proceedings to the Seventh Circuit Court of Appeals. Proponents and opponents of critical vendor orders hoped that the Seventh Circuit would clearly condone or condemn their use. However, the Seventh Circuit’s opinion of In re Kmart Corp., 359 F.3d 866 (7 th Cir. 2004), did not come close to meeting expectations. The Seventh Circuit was clear when it held that the Kmart critical vendor order could not stand, but it did not foreclose the possibility that it would uphold a future critical vendor order entered in the appropriate circumstances. Facts : Kmart commenced a voluntary chapter 11 case in January 2002. On the first day of the case, Kmart filed a motion seeking to pay certain of its creditors, unidentified in the motion, at least a portion of the pre-petition debt due, a motion commonly known as a “critical-vendors motion.” Kmart sought that relief because the bankruptcy code prevents a debtor from paying pre-petition debts on a post-petition basis without court authority. The premise of the critical vendors motion and order is that absent payment to certain creditors on pre-petition debts, the creditors will cease doing business with Kmart on a post-petition basis. The resulting harm to Kmart will be so severe that Kmart may be unable to reorganize. Put another way, paying certain creditors’ pre-petition debt in full, or in part (the amount to be left up to Kmart), immediately would result in a successful reorganization, thereby providing the non-critical vendors with more than they would have received absent the critical vendor payments. “Bankruptcy Judge Sonderby entered a critical-vendors order just as Kmart proposed it, without notifying any disfavored creditors, without receiving any pertinent evidence (the record contains only some sketchy representations by counsel plus unhelpful testimony by Kmart’s CEO, who could not speak for the vendors), and without making any finding of fact that the disfavored creditors would gain or even come out even.” Kmart, 359 F.3d 866, 2004 U.S. App. LEXIS 3397 at *2. Additionally, the “order did not explain why, nor did it contain any legal analysis, though it did cite 11 U.S.C. § 105(a).” Id. Kmart subsequently paid certain creditors approximately $300 million collectively on pre-petition debts. A creditor that did not receive any payments appealed Judge Sonderby’s order to the United States District Court for the Northern District Illinois, Eastern Division. The District Court appellant claimed that the critical vendors order violated the priority and distribution scheme of the Bankruptcy Code. District Court John F. Grady reversed the critical vendors order. Kmart appealed the decision to the Seventh Circuit. During the appeals process Kmart confirmed a plan of reorganization that provided for a distribution to unsecured creditors of approximately 10 cents on the dollar in reorganized Kmart stock. Id. at *3. Discussion : Prior to reaching the merits of the dispute, the Seventh Circuit dispensed with two arguments raised by critical vendors that were allowed to intervene as appellants. The vendor appellants argued that it was too late for the Court to address the appropriateness of the critical vendor order because promises had been made, goods sold and money paid. The Court rejected that argument indicating that Kmart preserved the right to pursue preferential payments, such as those made improperly pursuant to an unlawful critical vendor order, in its confirmed plan and that the concept of detrimental reliance did not apply. Specifically, the Court noted that it is an “ordinary function” of bankruptcy practice for a trustee or debtor-in-possession to recover payments that were made prior to or during a case that became improper after the fact. Id. at *4. Moreover, detrimental reliance was not applicable because nothing that occurred harmed the critical vendors. While it is true that the pre-petition payments may have helped their decision to continue shipping goods or providing services on a post-petition basis, they were certainly not harmed by doing so. “If Kmart had become administratively insolvent, and unable to compensate the vendors for post-petition transactions, then it might make sense to permit vendors to retain payments under the critical vendors order, at least to the extent of the post-petition deficiency.” Id. at *6 (emphasis added). However, since that did not occur, the critical vendors could not say they relied upon the critical vendors order to their detriment. The second procedural issue raised by one appellant, Handleman, was a perceived lack of adequate notice. Handleman claimed that the appeal was improper because it was not provided with notice of the appeal from the bankruptcy court to the district court. The Kmart Court easily dealt with that issue by indicating that if the “lack of personal notice about the proceedings before the district judge deprived Handleman of due process, then Kmart’s [ex-parte] application to the bankruptcy judge deprived about 47,000 unsecured creditors of due process.” Id. at *8. Finally, the Court turned to the merits of the case. The bankruptcy court did not cite to any authority in support of the entry of the critical vendors order except 11 U.S.C. § 105. One thing the Seventh Circuit made clear is that section 105 is not proper grounds for entry of a critical vendor order. “Every circuit that has considered the question has held that [section 105] does not allow a bankruptcy judge to authorize full payment of any unsecured debt, unless all unsecured creditors in the class are paid in full . . . We agree with this view of § 105.” Id. at *10-11 (citations omitted). The Court also dispelled any notion that a proponent of a critical vendor motion could rely upon the doctrine of necessity: “A ‘doctrine of necessity’ is just a fancy name for a power to depart from the Code.” Id. at *11. The Court then turned its attention to other sections of the Code that the appellants asserted could provide the authority for unequal treatment of creditors: 11 U.S.C. §§ 363(b), 364(b) and 503. The Court found that a critical vendor order could not be entered pursuant to sections 364(b) and 503 under any set of circumstances. Section 364(b) “authorizes the debtor to obtain credit (as Kmart did) but has nothing to say about how the money will be disbursed or about priorities among creditors.” Id. at *13. The Court also found section 503 inapplicable because it deals with administrative expense claims incurred on a post-petition basis. Therefore, it has no application to pre-petition debts. Id. (“Treating pre-filing debts as ‘administrative’ claims against the post-filing entity would impair the ability of bankruptcy law to prevent old debts from sinking a viable firm”). After dispensing quickly with those arguments, the Court turned to section 363(b)(1), about which it noted: “This is more promising.” Id. at *14. The Court stated that there is a possibility that section 363(b)(1) could be used to change the payment priority scheme of the Code. Id. That said, the Court stopped short of saying whether it thought it would be proper to do so: “Nonetheless, it is prudent to read, and use, § 363(b)(1) to do the least damage possible to the priorities established by contract and by other parts of the Bankruptcy Code. We need not decide whether § 363(b)(1) could support payment of some pre-petition debts, because this order was unsound no matter how one reads § 363(b)(1).” Id. at *15 (emphasis in original). Although its holding left the question of whether § 363(b)(1) could authorize a bankruptcy court to enter a critical vendor order, the Court identified specifically what a bankruptcy court must find factually before entering such an order. The “debtor must prove, and not just allege, two things: that, but for immediate full payment, vendors would cease dealing; and that the business will gain enough from continued transactions with the favored vendors to provide some residual benefit to the remaining, disfavored creditors, or at least leave them no worse off.” Id. at *1-2. After identifying the test, the Court seemed to indicate that it was unlikely that a debtor would be in a position to prove that a vendor would cease doing business with it. “Each new delivery produced a profit; as long as Kmart continued to pay for new product, why would any vendor drop the account? That would be a self-inflicted wound. To abjure new profits because of old debts would be to commit the sunk-cost fallacy; well-managed businesses are unlikely to do this.” Id. at *17. The Court understood that its statement presupposed the answer to a significant question: would the debtor be able to continue to pay for the new product. However, rather than relying upon the payment of pre-petition debt as an indicator, the Court suggested that the creditor should focus solely on determining whether its post-petition invoices would be paid. Recognizing that COD may not be the best option for a debtor, the Court suggested another scenario involving a standby letter of credit. Instead of using the cash to pay pre-petition debt, it would be used as collateral for a letter of credit, which would allow the vendors to draw when its post-petition invoices would be due. That scenario would leave no doubt that the vendors would be paid currently on a post-petition basis. And if the debtor were unable to obtain a letter of credit, “that would be a compelling market signal that reorganization is a poor prospect and that the debtor should be liquidated post haste.” Id . at *18. Comment: The Seventh Circuit put an end to the use of section 105 and the doctrine of necessity as legal support for critical vendor motions, a holding which many bankruptcy courts are sure to follow. In doing so, it also declared other sections of the Code inapplicable, but left open the question of whether section 363(b)(1) could provide a sound basis for the entry of a critical vendor order. Although not required to, the Seventh Circuit also provided the factual framework it deems necessary for a bankruptcy court to apply in determining whether there is a sound factual basis for entry of a critical vendor order. Overall, unless you are involved in a proceeding before a bankruptcy court in the Seventh Circuit, the Kmart holding is purely persuasive. It is unknown at this point how persuasive the decision proves to be. Richard E. Kruger Case Law UpdateDebtor-In-Possession Permitted to Assume an Unexpired Lease Without First Curing Non-Monetary Defaults. Disagreeing with the Ninth Circuit, the First Circuit held that § 365(b)(2)(D) permits the debtor-in-possession to assume an unexpired lease without first curing non-monetary defaults. Court held that preventing a debtor from assuming a contract based on historical events that it could not remedy undermined Congress's basic purpose in § 365 to promote the successful rehabilitation of the business for the benefit of both the debtor and all its creditors. Congress meant §365(b)(2)(D) to excuse debtors from the obligation to cure non-monetary defaults as a condition of assumption. The ipso facto defaults described in § 365(b)(2)(A)-(C) were not necessarily non-monetary and would not be rendered superfluous. Under § 365(b)(2)(D), the debtor did not need to cure non-monetary defaults before assuming its equipment leases with the lessees, which cleared the way for the debtor to assume the leases with bankruptcy court approval and to seek to collect $1 million in outstanding rent. Eagle Ins. Co. v. Bankvest Capital Corp. (In re Bankvest Capital), 360 F.3d 291 (1st Cir. Mar. 15, 2004). Section 365(c)(1)’s “Assumption or Assignment” Clause Dictates Two Distinctive Events. The Court held that assumption and assignment are two distinct events under § 365(c)(1), and the non-debtor must consent to each independently. Under the plain language of §365(c)(1), therefore, two independent events must occur before a Chapter 11 debtor in possession is entitled to assign an executory contract. The debtor in possession must first obtain the non-debtor's consent to assume the contract, and it must thereafter obtain the non-debtor's consent to assign the contract. Therefore, where a non-debtor consents to the assumption of an executory contract, § 365(c)(1) will have to be applied a second time if the debtor in possession wishes to assign the contract in question. And in the second application of § 365(c)(1), the issue is whether applicable law excuses a party from accepting performance from or rendering performance to an entity other than the debtor in possession. RCI Technology Corp. v. Sunterra Corp. (In re Sunterra Corp.), 361 F.3d 257 (4th Cir. Mar. 18, 2004). Unissued Preferred Stock Did Not Constitute An Interest of the Debtor in the Property. Unissued stock was found to be of no value to the corporation, as opposed to its shareholders, because stock only represented portions of equity in the corporation itself. In determining what constitutes “an interest of a debtor in property,” the Court ruled that unissued stock is not an interest of the debtor corporation in property; it is merely equity in the corporation itself. Decker v. Advantage Fund Ltd., 2004 U.S. App. LEXIS 5755 (9th Cir. Mar. 29, 2004). Obligation Under Lease Arising on Lease’s Termination Does Not Qualify As An Administrative Expense Claim. Debtor’s commercial lease required the removal of all fixtures and equipment on the premises on termination of the lease. Debtor constructed a building on the premises. Subsequently debtor filed for bankruptcy and removed the building from the premises. However, debtor failed to remove a concrete slab or restore the lease premises as required. Debtor rejected the lease and creditor filed an administrative expense claim for debtor’s failure to remove the slab and restore the premises. The Court held that creditor’s claim on the removal obligation did not qualify as an administrative expense claim where the removal obligation arose on the lease’s termination, where the termination occurred when debtor rejected the lease, and where debtor’s obligation did not arise pre-rejection. The court also held that creditor’s claim on the maintenance obligation did not qualify as an administrative expense where the maintenance obligation was breached only when debtor rejected lease. K-4 v. Midway Engineered Wood Prod., Inc. (In re Treesource Indust., Inc.), 2004 U.S. App. LEXIS 7033 (9th Cir. Apr. 12, 2004). Enforceability in Bankruptcy of Agreements That Allow the Subordination of Certain Indebtedness. Court first determined that the enactment of § 510(a) of the Bankruptcy Reform Act of 1978 extinguished the Rule of Explicitness in its classic form. The Court further held that states are not free to adopt rules of contract interpretation that apply only in bankruptcy. The Court found the Rule of Explicitness was not applicable because New York law had not adopted it as a rule of general applicability. Instead, the state had applied it only in the bankruptcy context. Turning to generic principles of state law to interpret the subordination agreements at issue, the Court found the subordination provisions ambiguous as to whether they provided for the priority payment of post-petition interest. This finding necessitated an examination into the intent of the parties. That inquiry, in the circumstances of the case, entailed questions of fact that had to be addressed by the bankruptcy court. HSBC Bank USA v. Branch (In re Bank of New England Corp.), 2004 U.S. App. LEXIS 7124 (1st Cir. Apr. 13, 2004). Interplay Among §§ 1141(d)(2), 523(a)(1)(A), and 507(a)(8) Rendered an IRS Claim for Unpaid Taxes Non-Dischargeable Regardless of Whether Claim was Secured. Relying on the unambiguous text of §§ 523(a)(1)(A) and 507(a)(8) and the legislative purpose underlying the Code, the Ninth Circuit joined the Eleventh Circuit in holding that the interplay among §§ 1141(d)(2), 523(a)(1)(A), and 507(a)(8), renders an IRS claim for unpaid withholding taxes non-dischargeable by a confirmed Chapter 11 bankruptcy plan, whether or not that claim was secured. “There is no linguistic ambiguity in the interplay between § 507(a)(8), which only excepts allowed claims (while prioritizing allowed unsecured claims), and § 523(a)(1)(A), which excepts taxes from discharge whether or not they are allowed. The interplay between the two sections makes starkly clear that debts arising from a tax of the kind specified in § 507(a)(8) are excepted from discharge, regardless of their status as either secured or unsecured claims.” Miller v. United States, 2004 U.S. App. LEXIS 7120 (9th Cir. Apr. 13, 2004). Trustee Not Judicially Estopped From Pursuing Pre-Petition Claim Not Listed on Petition. Debtor failed to list claim against former employer as an asset on her Chapter 7 petition. Debtor was subsequently granted a “no asset” discharge. Trustee was informed of the failure to list the claim and was thereafter granted permission to reopen the bankruptcy case to allow further administration of the bankruptcy assets. Court held trustee was not judicially estopped from pursuing his claim on behalf of the debtor’s creditors. The Court reasoned that since a pre-petition cause of action is the property of the bankruptcy estate, such property includes causes of action belonging to the debtor at the commencement of the bankruptcy case, that only the trustee has standing to pursue the cause of action. Failure to list an interest on a bankruptcy schedule leaves that interest in the bankruptcy estate. Thus, the debtor’s employment claim became an asset of the bankruptcy estate when she filed her petition and the trustee then became the real party in interest in the debtor’s employment claim. Since the trustee never took an inconsistent position under oath with regard to the claim he was not judicially estopped from pursuing it. The Court also noted that although generally the trustee does not have any more rights than a debtor has, any post-petition conduct by the debtor, including the failure to disclose an asset, does not relate to the merits of the employment claim. Parker v. Wendy’s Intn’l, Inc., 2004 U.S. App. LEXIS 7559 (11th Cir. Apr. 15, 2004). Paige Barr Washington Hot NewsMeeting of the Judicial Conference Advisory Committee on Rules of Bankruptcy Procedure April 12, 2004 : The Judicial Conference Advisory Committee on Rules of Bankruptcy Procedure Advisory Committee has scheduled a two-day meeting on September 9-10, 2004 from 8:30 am to 5 pm at the Ritz Carlton, Montara Room, One Miramontes Point Road, Half Moon Bay, California. The meeting will be open to public observation but not participation. Bankruptcy not on Frist's radar April 9, 2004 : In recent statements, Senate Majority Leader Frist (R-TN)
has been outlining the agenda for the Senate for the upcoming months and also,
to some extent, the remainder of the session. Acknowledging time is "tight" Sen.
Frist has not mentioned bankruptcy, HR 975, as being on the short term list (the
next month or so) nor the list for the balance of the year. Supreme Court Decides Household Credit Services v. Pfennig SUPREME COURT OF THE UNITED STATES +++++++++++++++++++++++++++++++++++++++++++++ Syllabus can be found at: http://supct.law.cornell.edu/supct/html/02-857.ZS.html Full decision can be found at: http://supct.law.cornell.edu/supct/html/02-857.ZO.html
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I’d
like to break from writing about the usual and venture into a discussion of a
recent decision that appears to have no immediate bankruptcy relevance. Still,
it has unique import for those who practice in the bankruptcy forum. I refer
to Justice Scalia’s recent memorandum in the Cheney v. United States
District Court where Justice Scalia denied a motion to recuse.