Thursday, October 09, 2014

NCBJ 2014: Chapter 9, Closely Held Businesses, e-Discovery, Claims Buying and Sale Free and Clear of Interests

NCBJ is in Chicago this year.   The weather is pleasantly cool compared to the continuing Austin heat and the first day of CLE had some interesting programs.   Here is a wrap of Day 1, which included Chapter 9, reorganization for closely held companies, e-discovery, an economist from the Chicago Fed, claims trading and treatment of "interests" in section 363 sales.     I will divide the day between separate posts on the educational seminars and the economist's prognostications.  There will be another Fed economist speaking tomorrow.

Chapter 9:  Judge Steven Rhodes, Daniel Heimowitz (RBC Capital Markets), Marc Levinson  (Orrick, Herrington & Sutcliffe, LLP), Ron Oliner (Duane Morris) and Judge Elizabeth Perris

While Chapter 9 may seem exotic and unusual, three California Cities, as well as Detroit and Jefferson County, Alabama have all used this mechanism.   In Texas, it has been used on a smaller scale for many road and water districts.    

Municipal finance is big business.   There is about $3.7 trillion of municipal bonds outstanding with 11,464 issued during 2013.  Nevertheless, only about 4-5 default in any given year.   However, when they do, it creates a big stir.

The  most unique aspect of chapter 9 is its public nature.   Ron Oliner referred to the process as trying both "a political and a legal case" which is challenging for lawyers not used to dealing with the political process.   One of the speakers described dealing with the "crazy" ever present media and politicians and having clients constantly talking to the media to try to influence public opinion.   In the City of San Bernadino case, the City Attorney was recalled shortly after the case was filed, prompting the Mayor to state that the City Attorney's "26 year reign of terror" had ended.   Marc Levinson described the circus nature of city council meetings where decisions must be made in public.   Judge Perris, who has been the judicial mediator for several of the California cases, explained the difficulty of mediating cases where the principals could not be in the room due to open meetings law.  She also described having the media stake out mediations and reporting on the comings and goings of the various participants.   

One important issue discussed was eligibility.   There are several hoops that a municipality must jump through in order to qualify for relief, including being authorized to file by state law and having negotiated in good faith.   Conversely, if an entity is a municipality, it is not eligible to file for chapter 11.   The New York Off-Track Betting Corporation was found to be a municipality, while the Las Vegas Mono-Rail and the Orange County investment pool were not.   In re: New York Off-Track Betting Corporation, 427 B.R. 256 (Bankr. S.D. N.Y. 2010); In re Las Vegas Monorail Co., 429 B.R. 770 (Bankr. D. Nev. 2010); In re County of Orange, California, 183 B.R. 594 (Bankr. C.D. Cal. 1995).

Frequently, labor union difficulties are a factor in Chapter 9 cases.   Because section 1113 does not apply in Chapter 9, the more lenient standard of NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984) applies to rejection of collective bargaining agreements.   Nevertheless, the politics of public unions encourages negotiated solutions.  

The requirements to confirm a plan appear similar but are tricky.   When dealing with a secured creditor, it is often necessary to engage a municipal finance expert to determine whether the bond instrument has created a pledge of funds or merely provided for funds to be paid from a particular source.   The absolute priority rule has little application since municipalities do not have equity holders.   However, the necessity of obtaining bond financing in the future deters parties from burning bridges.    Feasibility is a challenge where projections must go out forty years.   

Judge Perris pointed out the importance of mediation in Chapter 9 cases, stating that the parties need to make deals and need to make peace.    She said that many of the players in Chapter 9 cases are repeat players and are constantly worrying about what will happen in the next case down the road.

All in the Family:  Advising the Closely Held Company: Whitman Holt (Klee, Tuchin, Bogdanoff & Stern, LLP), Mindy Mora (Bilzin, Sumberg, Baena, Price & Axelrod), Douglas Rosner (Goulston & Storrs) and Michael St. Patrick Baxter (Covington & Burling)

The panel discussed the importance of spelling out the nature of the representation.   Doug Rosner said that at the beginning of the representation when the interests of the company and the shareholder are blurred that "the conversation is equally blurred."   Mindy Mora suggested obtaining an initial engagement letter specifying that the firm represented both the individual and the company prior to bankruptcy but would be representing the company only once bankruptcy was filed.   Rosner said that when talking to the individual, "my job is to tell you when you need to talk to your own counsel."

They also discussed the plight of the independent director.   While an independent director is under no obligation to stay ("it's not maritime law, you don't have to go down with the ship"), the director may benefit from staying on because decisions made on advice of counsel will likely be protected and directors can obtain releases under a plan.

There was a lot of discussion about so-called "bad boy" guarantees, where the principal's liability is triggered by a bankruptcy filing.   This creates a conflict of interest between the individual's personal interest in not having the guaranty take effect and the fiduciary duty to the company and creditor's.  Interestingly enough, in one case, the springing guaranty took effect upon an involuntary bankruptcy filed by the lender who was the beneficiary of the provision.    The panel discussed the situation in the Extend-A-Stay case where the debtor's principal sued his personal counsel after they advised him that his exposure on a breach of fiduciary duty claim was greater than his springing guaranty.   However, the case was dismissed, which was affirmed on appeal.
Another conflict of interest arises from the attorney's retainer.    Without a retainer, the company cannot obtain competent counsel.    However, the company's funds are often subject to a creditor's liens.   If the company pays counsel with encumbered funds, counsel may be forced to disgorge and be disqualified.   Trying to launder the funds through a related entity is even worse.    

Pre-bankruptcy forebearance agreements are a trap for the unwary.   Lenders may insist upon waiver of the automatic stay, disgorgement of counsel's retainer and an unlimited guaranty from the principal while providing only limited forebearance.   (The correct answer here is not to agree to these provisions).

If the company does not file, it probably will not be able to protect the principal from suits while a plan is being negotiated.    Judge Allen Gropper has two recent decisions where he refused to grant a section 105 injunction to a restaurant owner being sued for wage violations.   In re SDNY 19 Mad Park, LLC, 2014 Bankr. LEXIS 3877 (Bankr. S.D.N.Y. 2014); In re Capitale I Ventures, LLC, 2014 Bankr LEXIS 3099 (Bankr. S.D. N.Y. 2014).    (Practice point:   don't stiff your employees if you plan to file chapter 11).     

Assuring eDiscovery Does Not Become eDisaster, District Judge James F. Holderman, Jason Lichter (Pepper Hamilton), Stephen Lerner (Squire Sanders), Camisha Simmons (Rose Norton Fulbright)

While I took a lot of notes from this panel, there were several top take-aways:
  • If you have an eDiscovery issue, tell your judge to call Judge Holderman.   Even though he was considerably older than his fellow panelists, he has worked through these issues extensively and is happy to discuss them with other judges.   His phone number is 312-435-5632.
  • The Seventh Circuit Electronic Discovery Pilot Program,, has lots of useful information, including forms and free webinars.    The Seventh Circuit is very proud of this site and it is the current judicial state of the art.
  • If the case is going to involve eDiscovery, have your client designate an eDiscovery Liason  and have her work with an eDiscovery Liason from your firm.   Make sure that your firm understands all there is to know about how your client collects, maintains and preserves electronically stored information (ESI).
  • The ABA has a Best Practices Report on Electronic Discovery (ESI) Issues in Bankruptcy Cases.
  • Before ESI issues arise in the case, develop an ESI Protocol with opposing counsel.   If opposing counsel won't agree, file a motion to establish one.   However, don't make it a first day motion.   An ESI Protocol can deal with issues such as clawback of privileged documents and parameters for searching documents.   For example, the parties could agree to a protocol that accepts that 80% accuracy in searching is acceptable.
The requirement to preserve ESI arises when an attorney "reasonably anticipates litigation."   The attorney should put in place a litigation hold consisting of written instructions to the client's custodians of ESI.

There are proposed amendments to the Federal Rules of Civil Procedure which will take effect on December 1, 2015 if approved by the Supreme Court.   Among them, Rule 37(e) will be amended to provide that a spoilation instruction can only be given where the court finds there was an "intent to deprive" the opposing party of ESI.   This would replace the current negligence standard applicable in some circuits (and no, I don't know which ones).    There is also a proposed amendment to Rule 26(b)(1) which will replace the reasonably calculated to lead to the discovery of admissible evidence standard with one which refers to information which is relevant and proportional to the needs of the case.   Proportionality looks to what is reasonable under the circumstances of the case given the resources of the parties.    

An interesting concept to discuss with your transactional lawyers is the litigation pre-nup.   It defines what ESI protocols the parties will use if there is ever litigation over the deal.   This may be the wave of the future.

The only bad thing about attending this program is that now I can't claim to be ignorant of these issues.

Bankruptcy and the Markets:  The Uneasy Relations Between Debtors, Traders and Judges: Judge Jeffrey Deller, David Eaton (Kirkland & Ellis),   Debra Grassgreen (Pachulski Stang, Ziehl & Jones), Thomas Moes Mayer (Kramer, Levin, Naftalis & Frankel, LLP), Jeffrey Rich (Rich Michaelson Magaliff Moser) 

The panel distinguished between strategic and non-strategic purchases of claims.   Non-strategic purchasing of claims is buying a claim in the hopes of recovering more than was paid.   Strategic claims purchasing, on the other hand, is purchase of claims with the intention of influencing the case.   This could mean attempting to obtain equity or control in the reorganized debtor or to block a plan and force a sale of the debtor's assets.   

Strategic claims purchases can be either good or bad depending on the motivation of the purchaser.   Good motivations are those which advance the purchaser's economic interest as a creditor.  Negative motivations can include driving a competitor out of business or extorting a disproportionate payment to stop interfering with the reorganization.   

Tools for dealing with improper use of purchased claims include designating the creditor's ballot under section 1126(e), equitable subordination and denying credit bidding.   Major cases include In re DBSD North America, Inc., 634 F.3d 79 (2nd Cir. 2011), where the court affirmed designation of the vote of a competitor who purchased claims for above par late in the case to block confirmation, In re Lightsquared, Inc., 513 B.R. 56 (Bankr. S.D. N.Y. 2014), where a creditor was allowed to vote despite an improper motive where plan was "abysmal" and any creditor would have opposed and, In re Fisker Auto Holdings, 510 B.R. 55 (Bankr. D. Del. 2014), where a creditor who purchased a claim was limited to credit bidding the amount it paid for the claim.

Section 363 Sales:  What You Get and What You are Stuck With:   Hon. David Coar (ret.), Barry Bressler (Schnader Harrison Segal & Lewis, LLP), Lisa Hill Fenning (Arnold & Porter), George W. Schuster (Wilmer Cutler Pickering Hale & Dorr), Richard W. Young (Quarles & Brady)

This panel examined what it means to sell property free and clear of "interests."   The first scenario it examined was successor liability.    In the case of  In re Trans World Airlines, Inc., 322 F.3d 283 (3rd Cir. 2003), the term "interests was defined broadly enough to extend to vouchers given to flight attendants in compromise of labor claims.    In Chrysler, the debtor proposed to sell the assets of the company and assume warranty claims for post-closing sales of vehicles but not pre-sale tort claims.   The Ad Hoc Committee of Consumer Claims appealed and the Second Circuit affirmed.  In re Chrysler, LLC, 576 F.3d 108 (2nd Cir. 2009).    The Supreme Court vacated the Second Circuit decision based on mootness.   Nevertheless, the Debtor later agreed to assume some claims for the purpose of preserving the value of unsold vehicles.    In General Motors, there was not a third party buyer.   The "sale" allocated 10% of the value in Newco for tort claimants and assumed liability for future tort claims.   However, the company did not disclose certain known claims based on cars switching off.

Intellectual property is another example of an interest possible "interest."    Intellectual property consists of patents and copyrights, which exist under federal law, trademarks, which exist under federal law, state law and common law, and trade secrets, which are created by common law.   

Liens on intellectual property can be perfected by filing under the UCC.  The Patent and Trademark Office can record an assignment of patents or copyrights but not a mortgage.   

Intellectual property can be transferred pursuant to exclusive license, non-exclusive license or sale.  An exclusive license allows the licensee to use the IP to the exclusion of other parties but may include a reversion to the licensor.  A non-exclusive licensee may use the IP but the licensor is free to grant licenses to multiple parties.   Finally, a complete transfer vests ownership in the IP to the purchaser.

A non-exclusive license may not be assigned without the consent of the licensor.   A true exclusive license may be assigned.   Originally, trademarks could not be licensed because they were identified with the owner.   However, the law subsequently allow trademarks to be licensed so long as the licensor controlled the quality.   

A debtor who is a licensee may not assign its license without consent of the licensor.   On the other hand, if the debtor is the licensor, it can assign its right to receive royalties.   However, a debtor may not sell its IP free and clear of existing licenses.   This is provided by section 365(n).        

Precision Indus., Inc. v. Qualitech Steel SBQ, LLC, 327 F.3d 537, 545 (7th Cir. 2003), Dishi & Sons v Bay Condos, LLC, 510 B.R. 696 (S.D.N.Y. 20140 and In re Spanish Peaks Holdings II, LLC, 2014 Bankr. LEXIS 913 (Bankr. D. Mt. 2014) are three cases dealing with whether property could be sold free and clear of the rights of others to use the property.   

Qualitech held that a debtor could sell property free and clear of the lessee's right to possession so long as the lessee was provided adequate protection.   The court reasoned that although the debtor could not dispossess the tenant by rejecting under section 365, section 363 allowed the sale free and clear of liens.

In Bay Condos, the Court also held that section 363(f) and 365(h) were not in conflict.  However, in order to sell under section 363(f), the debtor must meet one of five conditions stated.   While the tenants interests could have been extinguished under section 363(f), The Court found that section 363(f) would rarely ever allow a sale free and clear of the tenant's right to possession.  

Finally, in Spanish Peaks, the court found that the two sections were in conflict.   The Court allowed sale of the property free and clear of the interests of leases granted to insider affiliates of the debtor.

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