NCBJ 2022: The Role of the Bankruptcy Judge

 This panel asked the question, what is the role of the bankruptcy judge? To answer that question, they featured two retired judges, Judge Robert Drain from the Southern District of New York and Judge Harlan "Cooter" Hale from the Northern District of Texas along with sitting judges Erithe Smith from the Central District of California and Grace Robson from the Middle District of Florida. Rather than trying to recreate their panel, I will try to distill their presentation into a series of rules.

Two Cases Illustrate How to Bring a Chapter 11 Case to a (Successful) End

This is an article about the end of a Chapter 11 case.  As the Doors put it:

This is the end
Beautiful friend
This is the end
My only friend, the end

Of our elaborate plans, the end
Of everything that stands, the end
No safety or surprise, the end

All cases must come to an end.   Sometimes they linger on the docket until they smell like unwashed sweat socks stuffed behind the sofa.  Other times, the parties are eager to escape the scrutiny of the court and are looking for a creative way out.  This post focuses on how two cases reached their ends.

Structured Dismissal

In a recent case, Judge Harlin Hale wrote:

This case presents the issue of whether a bankruptcy court can approve a structured dismissal of a chapter 11 case, instead of conversion or forcing the parties to confirm a plan, when dismissal is what the parties want and is in the interest of creditors.

 In re Buffet Partners, L.P., et al, No. 14-30699 (Bankr. N.D. Tex. 7/23/14), p.1.    The opinion can be found here (PACER registration required).
     
What Happened:

Buffet Partners involved the Furr's restaurant chain's second trip to the bankruptcy buffet.   The Court entered an order approving the sale of substantially all of the company's assets within a little more than 90 days after filing.    The Debtor, the Purchaser and the Committee negotiated an agreement for funds to be set aside for the Debtor's and the Committee's professional fees as well as a stipend for unsecured creditors.   

The Debtor and the Committee then filed a motion to dismiss the cases upon certification that:  (1) the Committee had completed its reconciliation process; (2) all UST fees had been paid; (3) the Debtor had distributed funds to unsecured creditors according to a schedule to be filed with the Court; and (4) the Court had approved all final fee applications.   The UST was the only party to object, insisting that the case should be converted or that the Debtor be required to file a plan.

The Ruling:

The Court noted that, "Not much law, statutory or otherwise, exists regarding structured dismissals of this type."   Opinion, p. 4.    The Court concluded that structured dismissal was in the best interest of the creditors.   The Court stated:

In truth, in the present case, there is not much in the way of assets left to be administered. As noted by the In re OptInRealBig.com court, the economic value of the Debtor in this case will be served by dismissing the case, rather than converting it. Converting this case to chapter 7 would interfere with prompt and efficient payment to creditors, a primary goal of chapter 11. The parties with the skin in the game do not wish to prolong the distribution of funds to creditors by a conversion to chapter 7, which undoubtedly will do just that. Nor do those parties want to go through the time and expense of a plan, which will cause the pool of money left to be greatly diminished.

On a smaller scale, structured dismissals occur regularly in this and other bankruptcy courts. Often the parties enter the case on the eve of foreclosure, work out their differences through a sale or giveback of property, and the parties enter an agreement submitted to this court for approval that results in the dismissal of the case. This court begins its look at deals struck in this court with the eye that “it’s not my money.” If appropriate notice is given and the process is fair and does not illegally or unfairly trample on the rights of parties, the proposal should be approved.   (emphasis added).

 Opinion, p. 5.   

Having noted its deferential starting point, the Court stated that "parties do not have carte blanche to enter any settlement they choose."   Opinion, p. 6.    The Court found three criteria that must be met by a settlement of this type as defined by Fifth Circuit precedent:   (1)  senior interests must be given full priority over junior interests; (2) the settlement must not constitute a sub rosa plan;  and (3) the settlement must not discriminate unfairly against parties that have not objected to the proposal.    

There is an interesting tension in Judge Hale's discussion of the Fifth Circuit precedent.   On the one hand, the settlement must satisfy the absolute priority rule and not discriminate unfairly, both of which are requirements for a cram-down under section 1129(b).   On the other hand, the settlement must not be a sub rosa plan.   Thus, it must meet some of the most fundamental requirements for a plan without actually being a plan.    The Court found that the proposed structured dismissal did not prefer junior interests over senior ones and that the settlement did not discriminate unfairly for the reason that there were no non-consenting creditors.   The Court stated that "(a)lthough certain aspects of this dismissal are 'structured,' it does not rise to the level of a sub rosa plan."   Opinion, p. 6.

In conclusion, the Court stated:

It is important to emphasize that not one party with an economic stake in the case has objected to the dismissal in this manner. While this fact is not outcome determinative, it is still worthy of consideration. All of the following parties affirmatively assent to the proposed dismissal: the Debtor, the Lender, and the Committee, which represents a large portion of the unsecured debt. The UST is the sole objecting party. This court does note that the UST is well within its rights to file the objection. The Bankruptcy Code gives thee UST standing. See 11 U.S.C. § 1109(b). In fact, this court looks to the UST to raise issues to cause it to stop and completely consider a matter even when no creditor objects.

Opinion, p. 7.   Here, once again, Judge Hale has stumbled upon an important truth.   Many parties (myself included) find objections from the U.S. Trustee to be an unwelcome annoyance, especially when the parties with an economic stake are in agreement.    However, the U.S. Trustee is given the institutional role of serving up issues for the Court to consider.  When the U.S. Trustee does so in a manner that is cogent and grounded in the Code, it does the parties and the Court a favor.

Of course, just because the UST raises an issue does not mean that the Court will adopt its position.  I am reminded of the scene in My Cousin Vinny where this exchange takes place:

Judge Haller:  Mr. Gambini . . . that is a lucid, intelligent, well thought-out objection.

Mr. Gambini:  Thank you, Your Honor.

Judge Haller:   Overruled.

While the U.S. Trustee was alone and unsuccessful in its objection, the end result was a useful opinion from the Court which will provide valuable guidance to future parties.

Final Decree

While the final decree under Bankruptcy Rule 3020 is the most common way to close a successful chapter 11 case, it is hard to find case law interpreting its requirements.   Judge Craig Gargotta recently added to this thin jurisprudence with his opinion in In re Valence Technology, Inc., No.  12-11580 (Bankr. W.D. Tex. 10/17/14).   The opinion can be found here.

 Debtor confirmed a plan on November 18, 2013 and the effective date occurred on December 4, 2013.    The Debtor appealed the orders partially allowing fees and expenses to two of its investment bankers.   Meanwhile, one of the investment bankers appealed the denial of its request for attorney's fees.   The Debtor requested entry of a final decree on the basis that the case had been "fully administered."   The investment bankers objected on the basis of the pending appeals.  They contended that without a pending case, there was no way to ensure that the Debtor paid their claims once the appeals process was concluded. 

Final decrees are governed by Bankruptcy Rule 3022, which allows the Court to enter a final decree "(a)fter an estate is fully administered in a chapter 11 reorganization case."

Judge Gargotta noted that many courts have relied upon the factors set out in the Advisory Committee Notes to Bankruptcy Rule 3022 in determining when a case has been fully administered.   These factors are:

Factors that the [bankruptcy] court should consider in determining whether the estate has been fully administered include (1) whether the order confirming the plan has become final, (2) whether deposits required by the plan have been distributed, (3) whether the property proposed by the plan to be transferred has been transferred, (4) whether the debtor or the successor of the debtor under the plan has assumed the business or the management of the property dealt with by the plan, (5) whether payments under the plan have commenced, and (6) whether all motions, contested matters, and adversary proceedings have been finally resolved.

Opinion, p. 3.   In the particular case, five out of six factors favored closing the case.   The Debtor further argued that closing the case would relieve it from the burden of paying U.S. Trustee fees and "remove the stigma of being in Chapter 11."    Id.  

The Court held that it was not necessary to meet all six factors and that courts agreed that a pending adversary proceeding alone was not sufficient to deny a closing order.    The Court also noted that the parties whose orders were being appealed could have protected themselves by requesting that the Debtor post a bond and could seek to reopen the case in the event that the Debtor needed to be persuaded to comply with the final orders on appeal.    As a result, the Court granted the application for final decree.

This opinion highlights the court taking a very practical approach to closing a case.   While there were matters still pending, the Bankruptcy Court was not directly involved in their resolution.   As a result, the Court concluded that leaving the case open as not being "fully administered" would be a matter of form over substance.

Note:   Procedurally, the party who would request a stay pending appeal and post a bond would be the appellant rather than the appellees.   However, the appellees could have forced the issue by seeking to execute upon the unstayed order which would have required the Debtor to seek a stay.

Ethics, Empiricists and International Insolvency at NCBJ

Saturday was the final day of the National Conference of Bankruptcy Judges.   The panels focused on ethics issues of the future, the role of empirical research and international insolvency.

Ethics

The first topic up on the ethics panel was reasonable investigation.    The hypothetical involved a lawyer who was unwittingly asked to facilitate money laundering and purchase of estate assets with hidden assets.   Recent cases to be aware of include In re Soare, 493 B.R. 158 (Bankr. D. Nev. 2013)(attorney who failed to investigate whether judgment was nondischargeable and then refused to represent debtor in nondischargeability action required to disgorge fees) and  In re Goodman, No. 12-1643 (9^th Cir. BAP 9/5/13)(sanctions against attorney for negligent representation affirmed)(unpublished opinion can be found here).   

We  learned that ABA opinion 465 says that there is not a per se prohibition on attorneys offering groupons.    (That doesn’t mean it’s a good idea, though).   

The Ethics 20/20 Commission is working on guidelines that would allow foreign lawyers to appear in U.S. proceedings on a pro hac vice basis.   However, a U.S. lawyer must reserve the absolute right to advice on American law.

Hunter v. Virginia State Bar, 744 S.E.2d 611 (Va. 2013) is an interesting case on the intersection between blogging and State Bar advertising requirements.   Hunter published a blog titled “This Week in Richmond Criminal Defense,” which was accessible from his firm’s website.    The overwhelming majority of posts were about cases in which he obtained favorable results for his clients.   The blog did not contain any disclaimers.   The Virginia Supreme Court found that Hunter’s blog constituted commercial speech subject to regulation by the Bar.    The Court found that the Bar could require Hunter to place disclaimers on his posts about his own cases to the effect that the results in the given case did not guarantee the same results for other people.    However, it found that the First Amendment allowed Hunter to discuss public details of his cases without the client’s permission.   A dissent would have found that the First Amendment prevented the Bar from regulating the blog.    

Muniz v. United Parcel Service, 2011 U.S. Dist. LEXIS 11219 (N.D. Cal. 2011) dealt with whether the defendant could subpoena the plaintiff’s lawyer’s postings to a listserv.    The Court quashed the subpoena.   The case illustrates the danger of revealing work product by posting on a listserv.

Empirical Research

The panel on empirical research features three academics:   Dean J. Richard Leonard of Campbell University School of Law, Prof. Theodore Eisenberg of Cornell Law School and Prof. Melissa Jacoby of UNC School of Law.   

Until recently, Dean Leonard was a bankruptcy judge.   He said that when he took the bench, he asked what he should read and was referred to Warren and Westbook’s empirical book, As We Forgive Our Debtors.   He pointed out that empirical studies published by just one law review, the American Bankruptcy Law Review, were cited in 32 opinions ranging from trial courts to the Supreme Court.   

Prof. Eisenberg said that empirical research can be used to disprove the conventional wisdom about bankruptcy.   He referred to the view that the American bankruptcy system is too pro-debtor and noted that the concept of a Debtor-in-Possession is shocking to other countries.   He pointed to empirical studies showing that U.S. reorganization cases paid 20% more to unsecured creditors than those in other countries.   Of twelve studies looking at payouts to unsecured creditors in different countries, the top five payouts were in American bankruptcies.   His conclusion was that the combination of the absolute priority and the Debtor-in-Possession led management to propose a higher dividend to unsecured creditors than plans in other countries.  

He also talked about the importance of studying fees.   He said, “From the day you graduate, (fees) will control your life.”    He said that big fees made news while small ones did not.   In this regard, he said that newspapers were just doing their jobs.   However, he said that the headlines did not reflect reality.  In smaller cases, the fees awarded average 17.6-21.6% of the assets of the debtor.  However, when the assets involved exceeded $100 million, the fees averaged 1-2% of assets.   He contended that fees charged by other professionals, such as investment bankers, charged more in fees.   

In an interesting study, courts denied requested fees at the following rates:

Delaware             0.74%

New York            4.50%

Everyone else      2.29%

While I did not catch his conclusion, mine would be that you can’t assume that judges in Delaware and New York always march in lockstep. 

Prof. Jacoby expressed the concern that empirical studies were too reactive.   She said that there were numerous studies framed in response to concerns that debtors were getting too much relief in bankruptcy.   She said that this approach was a limiting factor on the questions that academics ask and that academics should be more proactive in asking questions that others were not raising. 

Two random points that she made were that academics need more theory in empirical research and that empirical research meant observation and that academics should take the time to observe bankruptcy courts at work.

Prof. Eisenberg got on a soapbox about parties making unsubstantiated claims about the legal system.  He said:

You shouldn’t be able to stand in front of an audience and make nonsensical claims (with statistics).   The Chamber of Commerce does it every day.  

 He went on to say that we study areas that we care about, such as economic statistics.   He said:

You couldn’t say that the inflation rate is 20% (and get away with it).  However, you could say that plaintiffs are recovering multimillion dollar verdicts because of crazy juries. 

The learned professors also made two seemingly contradictory statements.   On the one hand, they stated that there is a lot of shoddy empirical research out there and that empirical studies should not be blindly accepted.   On the other hand, they said that the appeal of empirical research was the “ability of completely untrained people to get into it.”   I think that the point here was that anyone can pick a facet of the legal system to observe, but that it is helpful to partner with statistics geeks to help tell you the significance of what you observed.   (TBLB:  My words, not theirs).

International Insolvency:  The Good, the Bad and the Ugly

The international insolvency panel largely focused on three cases:  In re Lehman Brothers Holdings, Inc., No. 08-13555 (Bankr. S.D. N.Y.) (the good), In re Nortel Networks, Inc., No. 09-10138 (Bankr. D. Del.) (the bad) and Ad Hoc Group of Vitro Noteholders v. Vitro, SAB de CV (In re Vitro, SAB de CV), 701 F.3d 1031 (5^th Cir. 2012) (the ugly).   (The Clint Eastwood reference came from panelist Bruce Leonard).    The panelists were Judge James Peck from the Southern District of New York, Marc Adams of Wilkie Farr, Andrew Leblanc from Milbank Tweed and Bruce Leonard from the Ontario office of Cassels Brock.    In some cases, my notes do not indicate who said what so I will have to attribute comments generically to the panel. 

Before getting into the cases, Judge Peck provided an introduction to chapter 15.   Judge Peck noted that according to section 1501, the purpose of chapter 15 is to “incorporate the Model Law on Cross-Border Insolvency so as to provide effective mechanisms for dealing with cases of cross-border insolvency with the objectives of” increasing cooperation between courts of the United States and other countries.    However, as illustrated by the cases that followed, there are factors that get in the way of those purposes.

According to Mr. Abrams, chapter 15 is “the exclusive portal through which foreign representatives can seek assistance of the U.S. bankruptcy courts.”   Chapter 15 allows an American court to recognize and enforce orders and decrees from foreign courts.   It is not a reorganization chapter like chapter 11, but merely allows American courts to assist foreign courts with regard to assets of foreign entities in the United States.

Under Chapter 15, a foreign representative may seek recognition of a proceeding in another country as either a foreign main proceeding (Main Proceeding) or a foreign non-main proceeding (Non-Main Proceeding).    A Main Proceeding is one that is filed in the company’s center of main interest (COMI).    A Non-Main Proceeding is one filed anywhere else that the company has non-transitory economic activity.  A proceeding filed somewhere that is neither a COMI or has non-transitory economic activity is not entitled to recognition.    

Unlike the U.S. venue laws, the COMI determination pays little attention to the company’s domicile or state of incorporation.   Instead, it is more of a nerve center test.   While this may seem clear, Judge Peck commented that “what is written down is not necessarily clear until the circuit court tells you it is clear.”    In the recent case of Morning Mist Holdings Ltd. v. Krys (In re Fairfield Sentry Ltd.), 714 F.3d 127 (2d Cir. 2013), the Second Circuit held that COMI is determined as of the date of filing of the chapter 15 petition, so that activities of the foreign representative prior to the filing of the chapter 15 can change what would have otherwise been the COMI.  

   

The importance of being a Main Proceeding vs. a Non-Main Proceeding turns on sections 1520 and 1521.   Under section 1520, a Main Proceeding (which is a proceeding filed in the COMI) is entitled to automatic relief, including enforcement of the automatic stay and sales free and clear of liens for assets in the USA.    Under section 1521, there are various forms of discretionary relief that can be granted to either a Main Proceeding or a Non-Main Proceeding.

The panelists stated that Lehman Brothers and Nortel Networks shared many similarities.   Both were large entities with multi-national operations that took a major hit after the freeze of the credit markets in September 2008.   Nortel filed in September 2008, while Lehman Brothers held on until January 2009.   (TBLB:  The role of the U.S. government in orchestrating the filing of Lehman Brothers is well documented in the movie Too Big to Fail in which a committee of top economic advisors decides that Lehman Brothers should go ahead and file chapter 11 at which point someone asks whether the company should be informed).

In the Nortel case, the business operated in 140 countries through a series of five business lines as opposed to operating through subsidiaries.   It filed proceedings in the United States, Canada and the U.K.    The U.S. claimed priority based on the location of the assets, Canada claimed priority based on the company’s headquarters and the U.K. claimed dibs based on the location of the intellectual property.   The United States and Canadian proceedings recognized each other as contemplated by UNCITRAL.   The U.S. also recognized the U.K. proceeding as a Non-Main Proceeding.   However, the Canadian and U.K. administrators did not seek recognition of each other’s proceedings.  

Based on the view that the company’s assets were melting ice cubes, the three administrators quickly agreed upon a sale of the company’s assets for $7 billion.   However, four years later, the funds continue to sit in escrow because the parties could not agree upon a formula for allocating the sales proceeds.   After three failed mediations, a trial has been scheduled for 2014 with at least four competing formulas for distribution.   

Mr. Abrams commented that the Model Law was not well equipped to deal with the situation where there were three competing COMIs.

Judge Peck stated:

It is hard to design a law that gets to good results.   People have to get to good results.

The panel’s consensus was that because the Nortel assets were sold prior to obtaining an agreement for distribution of the proceeds that the parties lacked sufficient incentives to cooperate once the money was in the lockbox.   

According to Judge Peck, in Lehman Brothers, on the other hand, the assets were “not easily monetized” and “had to be cultivated.”   The only way to unlock the value was through a consensual plan, as opposed to Nortel where the creditors were in gridlock.    In Lehman Brothers, the parties negotiated a protocol for international cooperation and “based on the excuse given by the protocol, people talked to each other and developed a plan.” 

Vitro was a large Mexican glassmaker with U.S. debt.    It obtained approval of a concurso in Mexico and sought recognition in the United States.   In Mexico, all creditors vote together in a single class, including insiders and intercompany claims.   Furthermore, approval of a concurso constitutes a novation which releases all guarantors.   Finally, because a focus of the Mexican law is preserving jobs, a concurso must have the approval of equity.    

When Vitro sought recognition in the U.S., Judge Hale said no based primarily on section 1506, which states that relief need not be granted if it would be “manifestly contrary to the public policy of the United States.”     I have previously written about Judge Hale’s decision here.   The Fifth Circuit affirmed Judge Hale, but on different grounds.   You can find the Fifth Circuit opinion here.   The Fifth Circuit ruled that the granting of non-debtor releases is an issue that has divided the circuit courts.   Because federal courts do not agree upon this issue, allowing non-debtor releases could not be “manifestly contrary.”   Instead, the Fifth Circuit held that:

On the basis of the foregoing analysis, we hold that Vitro has not met its burden of showing that the relief requested under the Plan—a non-consensual discharge of non-debtor guarantors—is substantially in accordance with the circumstances that would warrant such relief in the United States. In so holding, we stress the deferential standard under which we review the bankruptcy court’s determination. It is not our role to determine whether the above-summarized evidence would lead us to the same conclusion. Our only task is to determine whether the bankruptcy court’s decision was reasonable.

Opinion, p. 58.  

The panel was critical of this opinion, asking whether it meant that the United States would be exporting its laws to other countries.    Judge Peck stated:

Recognition was intended to be a presumption to facilitate the reorganization goals of other jurisdictions.   Vitro seems to have changed that model.  

Mr. Abrams argued that:

The panel put blinders on when applying a plain meaning approach.

Abrams also said that he thought Judge Hale had the right approach in examining whether the result was manifestly contrary to the public policy of the United States, even though he did not agree with the Judge’s conclusion.  

 

The panel noted that the Fourth Circuit has opined that Courts should avoid reaching the section 1506 issue to avoid retaliation.   Judge Peck stated that:

I defer to a court that is at least civilized.

He gave the example of a case decided by a local court in India that he had deferred to.   

In the Fairfield Sentry case, the Second Circuit was asked to address the “manifestly contrary” issue in the context of a foreign proceeding in which the records had been sealed.   It held that open records were not a matter of such importance to US policy as to negate recognition.

Mr. Abrams concluded with the remark that

It is not time to trigger an Amber Alert for Chapter 15 and international cooperation yet.

Parting Thoughts:

This is a very good conference.   However, when I attend, I am usually pulling down long days and am mainlining coffee to stay awake.   I can’t help but notice that some very smart people are not very dynamic speakers.    If you are speaking at a conference as prestigious as the National Conference of Bankruptcy Judges, is it not too much to ask that you look up from your notes and speak loudly enough to be heard.    If you sound bored with your own presentation, you are probably putting your audience to sleep.   I would also like to put in a word for more diversity in program formats.     Four people on a one hour panel who don’t interact with each other is nothing more than a series of short monologues.   While brevity is much to be desired, fifteen minutes or less is not enough time to tell me something I don’t already know.   When it comes to putting together a panel, quality of content is to be desired over quantity of talking heads.    If you are going to put multiple people up there, make them interact with each other and preferably disagree on some things.   In the words of Robin Williams, “If you are going to go into the jungle, clash.”  The student loan debate was a good example of how to keep things lively.

Bankruptcy Court Denies Recognition to Non-Debtor Releases Contained in Mexican "Concurso"

In a major decision interpreting chapter 15 of the Bankruptcy Code, Judge Harlin Hale has denied recognition of the provisions of the “Concurso” order obtained by Vitro, SAB in Mexico which would have released the liability of its non-bankrupt U.S. subsidiaries.    The Court carefully avoided any rulings which would have cast aspersions upon the Mexican legal proceedings while finding that U.S. law would not recognize the specific provision.  In re Vitro, SAB, No. 11-33335 (Bankr. N.D. Tex. 6/13/12).   The opinion can be found here.   

What Happened

Vitro S.A.B. de C.V. is a holding company formed in Mexico in 1909.   It operates its business through a network of subsidiaries.   It is the largest manufacturer of glass containers and flat glass in Mexico and its name is Latin for glass.   Vitro borrowed approximately $1.225 billion in unsecured notes which were guaranteed by virtually all of its subsidiaries.   Vitro also agreed to repay approximately $2.0 billion to its subsidiaries under circumstances which raised questions from its third party creditors.

When the global recession hit in 2008, Vitro could not pay its debts.   In November and December  2010, proceedings were filed in four different jurisdictions seeking to address the Vitro debts.

1.                  On November 17, 2010, some of Vitro’s American creditors filed involuntary petitions against fifteen of Vitro’s American subsidiaries in the Bankruptcy Court for the Northern District of Texas.   Ultimately, four of the debtors consented to relief and an additional two debtors filed voluntary petitions.  

2.                  On December 2 and 9. 2010, Vitro’s American creditors filed suit against Vitro and 49 of its subsidiaries in state court in New York.

3.         On December 13, 2010, Vitro filed a a voluntary judicial reorganization proceeding under the Ley de Concursos Mercantiles (the “Mexican Business Reorganization Act”) in the Federal District Court for Civil and Labor Matters for the State of Nuevo León, the United States of Mexico, seeking approval of a pre-packaged, “concurso” restructuring plan.

4.                  On December 14, 2010, Vitro filed a chapter 15 proceeding in the Bankruptcy Court for the Southern District of New York.  

While these filings set up the multinational squabble, this was only the beginning.   In Mexico, the pre-pack was rejected based on a finding that the subsidiaries were not entitled to vote.   The initial chapter 15 petition in New York was withdrawn after this filing.   On appeal, the Mexican court reversed and allowed the subsidiaries to vote.  A new chapter 15 proceeding was filed in New York.   However, the New York chapter 15 proceeding was transferred to the Bankruptcy Court for the Northern District of Texas.   The Bankruptcy Court for the Northern District of Texas granted a preliminary injunction against proceedings against the Vitro parent but not the subsidiaries.    The American creditors sought an order prohibiting the American subsidiaries from voting upon the Mexican concurso but were rebuffed. 

 The Mexican concurso was ultimately approved based upon the votes of the subsidiaries.    The concurso provided that the guarantees of the subsidiaries could not be enforced.   Thus, the subsidiaries were able to vote in favor of a plan which released their guarantees.    This set the stage for the Mexican representative of Vitro to seek an order from the Bankruptcy Court for the Northern District of Texas recognizing the concurso and enforcing the order to release the subsidiaries from their guarantees.

            To summarize:

1.      Vitro borrowed over a billion dollars guaranteed by its subsidiaries.

2.      Vitro filed a pre-packaged bankruptcy plan in Mexico.

3.      Vitro’s pre-pack was approved based on the votes of its subsidiaries.

4.      The Mexican plan released the subsidiaries from liability.

5.      The Bankruptcy Court for the Northern District of Texas was asked to recognize the order from the Mexican Court.

 

The Comity Question

This left the Bankruptcy Court with a difficult question:   should it enforce the Mexican concurso as a matter of comity or was there a countervailing rule under American law?   Fortunately for the court, chapter 15 provides some guidance.    Under section 1507(b), an American bankruptcy court may provide “additional assistance” to a foreign debtor, but only if five conditions are met, including that  American creditors are treated fairly and the distribution scheme is substantially the same as provided under title 11.    Additionally, section 1506 allows the Bankruptcy Court to decline to enforce the order of a foreign court if it would be manifestly contrary to the public policy of the United States.”   

Whether to recognize a foreign court order under section 1507(b) is largely a matter of comity.   While comity and comedy sound very similar they have strikingly different meanings.   According to Judge Hale:

Comity should be the Court’s primary consideration when applying § 1507(b). (citation omitted).  Comity has been defined as the “recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience, and to the rights of its own citizens or of other persons who are under the protections of its laws.” (citation omitted). Granting comity to judgments in foreign bankruptcy proceedings is appropriate as long as U.S. parties are provided the same fundamental protections that litigants in the United States would receive.

. . .  “The principle of comity has never meant categorical deference to foreign proceedings. It is implicit in the concept that deference should be withheld where appropriate to avoid the violation of the laws, public policies, or rights of the citizens of the United States.”  (citations omitted).  

 Opinion, pp. 7-8.

In ruling upon the parties’ contentions, the Court divided its ruling into objections it rejected, objections it sustained and issues it did not reach.

The Court rejected the argument that it should not enforce the Mexican order because of corruption in Mexico.   While the creditors’ expert presented evidence of corruption in Mexico in general, it did not connect this to the specific case.   Additionally, the objecting creditors’ expert on Mexican law testified that in forty years’ practice, he had never bribed a judge.   While the Court’s conclusion appears to be sound, as well as avoiding offense to America’s neighbor to the south, the implicit suggestion that corruption should be proved by bringing testimony from a witness who has personally participated in corruption is a bit unsettling.

The Court also dismissed a number of arguments based on fairness and compliance of Mexican law on the basis that these were issues best left to the Mexican court system.  

However, in the end, the Court concluded that American law would not allow a plan of reorganization which granted wholesale releases to non-debtor parties.    The Court stated:

Generally speaking, the policy of the United States is against discharge of claims for entities other than a debtor in an insolvency proceeding, absent extraordinary circumstances not present in this case. Such policy was expressed by Congress in Bankruptcy Code Section 524, and in numerous cases in this circuit. (citations omitted). This protection of third party claims is described both in terms of jurisdiction and also as a policy. (citations omitted).

The Fifth Circuit has largely foreclosed non-consensual non-debtor releases and permanent injunctions outside of the context of mass tort claims being channeled toward a specific pool of assets.  (citations omitted).

Opinion, p. 25.   The Court ultimately concluded that the guarantor release provision of the concurso was contrary to American law and should not be enforced.    While the Court’s conclusion may be sound, it is curious that the Court did not discuss case law out of the Northern District of Texas allowing a plan to enjoin pursuit of claims against a non-party who contributes property necessary to the success of a plan which was approved by the creditors and will pay unsecured creditors 100% of the amount of their claims.  In re Bernard Steinhard Pianos USA, Inc., 292 B.R. 109 (Bankr. N.D. Tex. 2002); In re Seatco, Inc., 257 B.R. 469 (Bankr. N.D. Tex. 2001).    Perhaps the Court felt that those cases were too far different from those of Vitro.   However, an acknowledgement of what would constitute “extraordinary circumstances” would have been welcome.    

The bottom line here is that comity is a good thing, but not when it means an end run around American law as applied to American creditors of an American subsidiary of a foreign company.

The Fifth Circuit has approved a direct appeal and has temporarily stayed enforcement of the decision.

                       

Gadzooks! Northern District Judge Limits Impact of Pro-Snax

Judge Harlin Hale was just written an important opinion on attorney's fees in chapter 11. In re Gadzooks, Inc., No. 04-31486 (Bankr. N.D. Tex. 10/5/06). Judge Hale questions the applicability of the Fifth Circuit's Pro-Snax dicta in light of subsequent Supreme court precedent. Alternatively, he would limit the opinion to debtor's counsel in doomed cases.

A Little Background

Since the Bankruptcy Reform Act of 1978, bankruptcy has become big business. Large firms which once shunned bankruptcy as being beneath them now have large departments. As a result, issues relating to employing and compensating professionals are of keen interest to those who make their living in the bankruptcy world.

In 1998, the Fifth Circuit decided the narrow issue of whether the statutory language of 11 U.S.C. Section 330(a) allowed debtor's counsel to be compensated subsequent to appointment of a trustee. The Fifth Circuit followed the statutory language and said no. Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5th Cir. 1998). That result was subsequently upheld by the Supreme Court in another case. Lamie v. U.S. Trustee, 540 U.S. 526, 124 S.Ct. 1023 (2004). Not surprisingly, the Supreme Court said that courts should follow statute as written.

However, Pro-Snax had a second component to it. Because the firm was going to be able to receive some compensation, the Fifth Circuit gave instructions on how that compensation should be determined. The Court stated that in order to be compensable, services must result in an "identifiable, tangible and material benefit to the estate." The Court rejected the argument that services "need only be reasonable to be compensable." This holding arguably re-wrote the statute. Section 330(a)(4)(A) states that services may not be compensable if they "were not … reasonably likely to benefit the debtor’s estate or …necessary to the administration of the estate.” Since services "not ...reasonably likely" to benefit the estate could not be compensated, by negative implication, services which were reasonably likely to benefit the estate should be compensated even if they did not ultimately turn out to yield a benefit. It could be argued that while Pro-Snax was uniformly harsh toward debtors' counsel, it was schizophrenic when it came to statutory language; the primary holding was based on a strict reading of the statute, while the dicta edited out part of the text.

At least one court has held that, regardless of whether Pro-Snax properly read the statute, that it was still the law in the Fifth Circuit and should be followed. In re Weaver, 336 B.R. 115 (Bankr. W.D. Tex. 2005).

The Gadzooks Case

The recent opinion by Judge Hale addresses the situation where an Equity Security Holders Committee performed services which were objectively reasonable at the time they were performed, but did not yield a benefit to the equity holders for reasons beyond the committee's control. Gadzooks was a publicly traded company which catered to women between the ages of 14-22. At the time that it filed, equity was still in the money and the U.S. Trustee appointed an equity committee. The equity committee proposed a plan which could have paid unsecured creditors as much as 75% on their claims and would have allowed equity to buy back in. Unfortunately, the Debtor's sales tanked over the 2004 holiday season. As a result, the Debtor defaulted on its DIP financing, the proposed investment transaction was canceled and the equity committee was dissolved.

Hughes & Luce, the counsel to the equity committee, filed a fee application for approximately one million dollars. Both the creditors' committee and the liquidating trustee under the subsequently confirmed plan objected based on Pro-Snax. The case set up a perfect opportunity to examine the apparent conflict between Pro-Snax and Section 330(a). First, all parties stipulated that the services were reasonably calculated to provide a benefit up through the point that the Debtor's performance crashed. Second, the failure to achieve results was a result of factors the committee could not control. Third, the party making the request was not the debtor.

The Ruling

After a lengthy analysis, Judge Hale allowed compensation up until the point of futility for two independent reasons. First, Judge Hale applied the traditional lodestar analysis used by the Fifth Circuit prior to Pro-Snax to determine how much compensation was allowable. This conclusion was based on the preceeding analysis which rejected hindsight as a basis for denying fees. Judge Hale quoted the following language from the Supreme Court's Lamie opinion: "It is well established that 'when the statute's language is plain, the sole function of the courts--at least where the disposition required by the text is not absurd--is to enforce it according to its terms." Judge Hale added his own conclusion that, "This Court finds that, based on the wording in Section 330(a)(3) and (4), professional fees are not to be judged in hindsight."

Judge Hale relied on the intervening Supreme Court decision overturn the inconsistency in Pro-Snax.The Supreme Court said to follow the text of Section 330(a). The Pro-Snax dicta strayed from the text. Thus, while the Supreme Court upheld the holding in Pro-Snax, it implicitly rejected the dicta.

Judge Hale acknowledged that his ruling might be a little bold. He stated, "This Court realizes that its understanding of Pro-Snax may be misplaced. Certainly, other courts in Texas have constured the decision as requiring a hindsight analysis for professionals." Consequently, he offered a second rationale, finding that "Nevertheless, the Pro-Snax opinion is directed at a debtor's professionals, for obvious reasons--usually they have far more control over the reorganization efforts and strategy in a bankruptcy case. At least in Pro-Snax, they controlled the conversion to chapter 11 and the failed plan process." In his concluding paragraph, Judge Hale characterized Pro-Snax as "directed to professionals for the debtor who knew that their efforts were futile."

Judge Hale's order (which preceded the opinion) has already been appealed. Therefore it is likely that the Fifth Circuit will have the opportunity to revisit Pro-Snax in light of a decision squarely on point. If Gadzooks holds up, it will mean that professionals in bankruptcy will be less likely to have their fees denied based on factors beyond their control, such as poor holiday shopping sales. Of course, Gadzooks can't fix the largest problem in professional compensation--estates with no cash to pay professionals. However, it does remove an artificial roadblock.

Update:

On appeal, U.S. District Judge Jane Boyle reversed the Bankruptcy Court's opinion in Gadzooks. William Kaye vs. Hughes & Luce, LLP, No. 3:06-CV-01863-B (N.D. Tex. 7/13/07). Judge Boyle found that although the Fifth Circuit's Pro-Snax discussion of the correct standard to apply in awarding attorney's fees under Sec. 330 was dicta, that it was judicial dicta rather than obiter dicta. Judical dicta is defined as an opinion on an issue which was directly briefed and argued by the parties, but which was not essential to the decision. Judge Boyle found that judicial dicta should not be lightly disregarded. The Court also questioned whether the Circuit's instructions on the test to be applied on remand was really dicta at all.

The District Court engaged in a curious discussion of whether Pro-Snax was inconsistent with the language of Sec. 330. On the one hand, the District Court noted that it was bound to apply Pro-Snax regardless of whether it was correct and that many courts had disagreed with its logic. On the other hand, the District Court found that Sec. 330 could possibly be construed consistently with Pro-Snax.

Finally, the District Court rejected the Bankruptcy Court's attempt to limit Pro-Snax to its original context of awarding fees to debtor's counsel. The District Court found that the language of Sec. 330 did not distinguish between different types of professionals.

The District Court ruling has been appealed to the Fifth Circuit.