The Bankruptcy Opinions of Sonia Sotomayor

Yesterday President Obama nominated Second Circuit judge Sonia Sotomayor to take David Souter's place on the Supreme Court. As a District Court Judge in the Southern District of New York and as a Judge on the Second Circuit Court of Appeals, Judge Sotomayor has come across bankruptcy issues from time to time. However, few of her opinions are the stuff that casebooks are made of.

Big Bankruptcies: Routine Opinions

One consequence of sitting in New York is that Judge Sotomayor has written opinions in some major cases,such as Adelphia, Bethlehem Steel, Eastern Airlines, R.H. Macy & Co. and Worldcom. In In re Adelphia Communications Corporation, 544 F.3d 420 (2nd Cir. 2008), she affirmed the confirmation of a bankruptcy plan which transferred claims being asserted by an Equity Committee to a plan trust. The problem was that the Equity Committee, which was far out of the money, had confused derivative standing to pursue claims on behalf of the estate with ownership of the claims themselves. As Judge Sotomayor stated:

We do not mean to trivialize, but only to place in context, the role of the derivative plaintiff. It serves "with the approval and supervision of a bankruptcy court" and shares the "labor" of litigation with the debtor-in-possession. (citation omitted). Contrary to the Equity Committee's arguments, however, it does not usurp the central role of the court or debtor in overseeing and managing the estate's legal claims.

In Official Committee of Unsecured Creditors v. Securities and Exchange Commission, 467 F.3d 73 (2nd 2005), an interesting provision of Sarbanes-Oxley came into play. The SEC brought claims on behalf of defrauded investors, which the debtor settled. The SEC then proposed its plan for distributing those funds to the investors. The Unsecured Creditors Committee didn't like the SEC's plan (which was separate from the plan of reorganization in the case). Judge Sotomayor held that the Official Committee of Unsecured Creditors had standing to appeal, even though it was not a party to the SEC action, but ruled against them on the merits. In another Worldcom appeal, she held that the confirmed plan of reorganization barred pursuit of a discharged claim. In re Worldcom, Inc., 546 F.3d 211 (2nd Cir. 2008).

In another case, the judge ruled that employee benefits earned by an employee over the course of his employment but payable when he was discharged during the bankruptcy were not entitled to administrative claim status because the right to payment had accrued pre-petition. In re Bethlehem Steel Corporation, 479 F.3d 167 (2nd Cir. 2007).

As a district court judge, she ruled on an appeal concerning whether a tax assessed post-petition and payable under an unexpired lease which was later rejected was entitled to administrative priority. She affirmed the ruling of the Bankruptcy Court which had found it to be an administrative claim. In re R.H. Macy & Co., 1994 U.S. Dist. LEXIS 21364 (S.D. N.Y. 2004). The most interesting thing about this opinion is that it consists of a transcript of her discussion with counsel on the record before she made her ruling. She displays a bit of humanity when she apologizes to counsel for her delay in ruling and acknowledges some unfamiliarity with the bankruptcy issues.

THE COURT: How are you counsel? I must apologize for the delay in addressing this case. There is no excuse other than the press of life in general in the court-house. You have also presented me with interesting issues, so once I did turn my attention to it, it has not been easy for me to resolve.

I have a series of questions for those of you who are bankruptcy lawyers. I would like to have you educate me and focus me a little bit.

In the Eastern Airlines case, the Bankruptcy Court approved a comprehensive settlement between the Debtor and the Airline Pilots Association. A group of dissident pilots objected to the settlement and appealed. Judge Sotomayor found that the settlement was not an abuse of discretion. Nellis v. Shugrue, 165 B.R. 115 (S.D. N.Y. 1994).

International Insolvency

Judge Sotomayor has also had a passing acquaintance with international insolvency cases. In In re Board of Directors of Telecom Argentina, S.A., 528 F.3d 162 (2nd Cir. 2008), she affirmed the decision to recognize a foreign proceeding under former Section 304. In Petition of Alison J. Treco and David Patrick Hamilton as liquidators of Meridien International Bank Ltd., 205 B.R. 358 (S.D. N.Y. 1997) and Allstate Insurance Company v. Hughes, 174 B.R. 884 (S.D. N.Y. 1994) she affirmed the granting of a Section 304 injunction to protect the assets of a foreign debtor.

Dischargeability of Debts

Judge Sotomayor has written several opinions dealing with dischargeability of marital obligations. In re Maddigan, 312 F.3d 589 (2nd Cir. 2002)(attorney's fees incurred in connection with support claim were nondischargeable under Section 523(a)(5)); Beier v. Beier, 1995 U.S. Dist. LEXIS 1702 (S.D. N.Y. 1995)(granting summary judgment on non-dischargeability was inappropriate when there were issues of fact)

She also ruled that in determining the dischargeability of a claim arising under a settlement agreement, it was appropriate to look to the facts surrounding the underlying claim. In re DeTrano, 326 F.3d 319 (2nd Cir. 2003).

In European American Bank v. Benedict, 1995 U.S. Dist. LEXIS 10051 (S.D. N.Y. 1995),Judge Sotomayor ruled that the deadline to file a complaint to determine dischargeability could not be extended after the expiration of the deadline.

Other Rulings

In re Millenium Seacarriers, Inc., 419 F.3d 83 (2nd Cir. 2005)(bankruptcy court's jurisdiction over property of the estate wherever located included jurisdiction to extinguish maritime liens).

Harris v. Albany County Office, 464 F.3d 263 (2nd Cir. 2006)(dismissing appeal based upon failure to provide designation of record on appeal and transcript was abuse of discretion where debtor was not given opportunity to cure defect first)

Beightol v. UBS Painewebber, Inc., 354 F.3d 187 (2nd Cir. 2004)(no appeal from order denying motion to abstain)

In re New Haven Projects Ltd. Liability Co., 225 F.3d 283 (2nd Cir. 2000)(where Section 505 gave bankruptcy court discretionary authority to redetermine tax liability it was not error for bankruptcy court to decline to exercise that authority).

In re Seatrain Lines, Inc., 198 B.R. 45 (S.D. N.Y. 1996)(debtor's action against insurer which denied indemnification post-petition was core proceeding so that reference would not be withdrawn).

Royal American Insurance Co. v. McCrory Corporation, 1996 U.S. Dist. LEXIS 5552 (S.D.N.Y. 1996)(bankruptcy court erred in refusing to lift stay to pursue suit against debtor's insurance carrier despite fact that claimant had failed to file a timely claim against debtor).

In re St. Johnsbury Trucking Company, Inc., 191 B.R. 22 (S.D. N.Y. 1995)(Negotiated Rates Act of 1993 was constitutional as applied in bankruptcy, but issue would be certified for interlocutory appeal).

First Fidelity Bank, N.A. v. Eleven Hundred Metroplex Associates, 190 B.R. 510 (S.D. N.Y. 1995)(order for use of cash collateral reversed where debtor made absolute assignment of rents)

In re Friedman & Shapiro, Inc., 185 B.R. 143 (S.D. N.Y. 1995)(disciplinary proceeding against attornrey by state bar could not be removed based upon law firm's pending bankruptcy).

Kuntz v. Pardo, 160 B.R. 35 (S.D. N.Y. 1993)(litigant whose appeal was dismissed for failure to designate record did not demonstrate excusable neglect entitling him to reinstatement of appeal)

The Bottom Line

In ten years as a circuit court judge, Judge Sotomayor has authored 232 opinions, twelve of which have concerned substantive bankruptcy issues. In eleven out of twelve cases, she affirmed the lower courts. Remarkably, her six year record as a district court judge contains many bankruptcy rulings. Her bankruptcy opinions appear to be competently written, although none jump out as having changed the face of the law.

For another perspective on the Sotomayor nomination, go to The Case Against Sonia Sotomayor: Arch-Conservative .

Lawyers, Guns and Money

"Send lawyers, guns and money."--Warren Zevon (1978).

A new opinion out of San Antonio (home to the Alamo) contains the elements of lawyers, guns and money in a decision about exempting firearms. In re Wilkinson, No. 07-50189 (Bankr. W.D. Tex. 4/10/09). While I enjoyed the analysis, I don't think I would have arrived at the same conclusion. (Of course, I don't wear a black robe, so whether I agree or disagree is somewhat academic).

Dr. Wilkinson had guns. Lots of guns. Some of them could shoot. Others were mounted on the wall with brass plates describing them. The Debtor sought to keep two guns under the firearms exemption, but also sought to keep the mounted guns as home furnishings. The trustee cried foul, arguing that "firearms are firearms and cannot be claimed under another category such as 'home furnishings.'"

The Debtor's first shot (pun intended) was to point to a statute which said that antique or curio guns manufactured before 1899 were not guns. Texas Penal Code Sec. 46.01. This was a nice try, since the creative debtor's lawyer found a statute which said that the mounted guns were not legally firearms. However, this shot was easily deflected by the judge. The Penal Code dealt with guns which could not be possessed by felons. Since guns which cannot go bang are not inherently dangerous in the hands of a felon, their possession should not be criminalized. However, the statute didn't really answer the question of whether antique firearms mounted on plaques should be excluded from the definition of firearms under an exemption statute.

Next, the court considered the definition of firearm in common parlance. The court noted that:

Notably, none of these definitions excludes antique firearms or guns from the definition of what constitutes a firearm. None of these definitions requires that the item be in working order to constitute a firearm.

Opinion, p. 11.

The Court then went on an interesting historical analysis which demonstrated that guns have not always been sancrosanct in Texas. The Court noted that in Choate v. Redding, 18 Tex. 579 (1857), the Texas Supreme Court bemoaned the fact that there was no exemption for guns in Texas. This was especially troubling because Texas law required that every able-bodied man bring a gun in connection with their militia service. (This was back in the good old days when gun ownership was not only allowed but mandated!) Thus, if a creditor levied upon a debtor's non-exempt gun and he was called up for militia service, the debtor could be punished for showing up disarmed.

The lackadaisical legislature did not allow a gun to be exempted until 1870 and tardily expanded this exemption to two guns in 1973. The court concluded that because the legislature had to be dragged kicking and screaming to allow even two guns to be exempted that it would not allow more than that to be exempted under the guise of home furnishings.

I find the historical analysis interesting. I had always thought that the exemption for two guns was meant to allow Pa to shoot one gun out the front door while Ma defended the back of the house. Since the exemption for two guns did not come around until 1973 when the risk of marauding indians was substantially diminished, this assumption was probably incorrect. Hopefully none of my clients who I told this story to will ask for their money back.

However, I think that the court was asking the wrong question. The Debtor sought to exempt the mounted firearms as home furnishings rather than as firearms. Thus, the relevant question should be whether a mounted gun which doesn't go bang could be considered to be a home furnishing. A home furnishing is something that is used to furnish a home. (While I don't have any authority for this proposition, it is based on the close proximity between home and furnishing in the statute). Texans are granted great leeway in deciding how they will furnish their homes. They may decide to decorate their homes with tasteful artwork bought in galleries in Santa Fe and Taos or they may decide to build elaborate displays of Lone Star beer bottles and photographs of road kill. Likewise, both a display case containing pre-Columbian pottery and a collection of sweatstained tshirts from the Capital 10,000 neatly mounted in a shadow box could be a home furnishing. How you furnish your home is largely in the eyes of the beholder.

In my mind, whether a gun is exempt as a gun or a home furnishing depends on how it is actually used. If it is kept in a gun safe with suitable ammunition nearby, it is only exempt as a firearm or possibly as a tool of the trade in the case of a law enforcement officer. On the other hand, if it is mounted and the wall and doesn't go bang, then it is probably being used as an adornment or decoration and thus would fit the definition of a home furnishing. Just because the same item could potentially be exempted under one category should not prohibit it from being claimed under another applicable provision. Function, not origin, should determine the appropriate category for exemption. The mounted firearms seem an easy case to me. The harder case would be the debtor who decorated the inside of his closet with $60,000 worth of gold bullion. If the interest in decorating with gold arose on the eve of bankruptcy and the gold was not prominently displayed to visitors, that would probably not be a real home furnishing.

Court Clears the Way for Simultantaneous Causes of Action Based on Discharge Violation

Nature abhors a vacuum. When Congress restricted access to bankruptcy in 2005, many debtor’s lawyers became plaintiff’s lawyers, filing suit over automatic stay and discharge violations which might have been allowed to pass in an earlier time. Not only are debtor’s lawyers suing more often, they are also asserting more causes of action as illustrated by a recent opinion from the Western District of Texas. Eastman v. Baker Recovery Services, Adv. No. 08-5055 (Bankr. W.D. Tex. 4/17/09).

Eastman shows a common fact pattern. A debtor filed a no asset case and failed to schedule a creditor. The unscheduled creditor later filed suit. The debtor did not answer the suit, but did inform the creditor of the discharge. The creditor took a default judgment. Several years later, after the debtor moved to reopen her bankruptcy case, the creditor finally had the judgment vacated. The debtor then filed an adversary proceeding for violation of the discharge after the judgment had been vacated. However, the debtor not only filed suit for violation of the discharge, but for violation of the Fair Debt Collection Practices Act, the Texas Debt Collection Practices Act, the Texas Deceptive Trade Practices Act and “tortiously engaged in practices that rise to the intentional infliction of emotional distress” (whatever that means).

This case shows a pattern of escalating failures which is not that unusual. The debtor blundered by not listing the creditor. However, because the case was a no-asset case, the debt was still subject to discharge. The creditor’s initial action to file suit in violation of the discharge was innocent because the creditor did not have notice of the bankruptcy case. The debtor blundered a second time when it did not answer the state court lawsuit. The creditor blundered when it took a judgment after being informed of the discharge. The debtor showed a curious indifference to her own rights when she waited for over a year to remedy the discharge violation. The creditor showed a cavalier disregard for its own liability when it waited until after the debtor had moved to reopen the bankruptcy case before it got around to vacating the judgment.

This case raises two issues 1) Can the same violation of the discharge give rise to multiple causes of action? and 2) Does the Bankruptcy Court have jurisdiction to hear all of them? Judge Clark answered yes to both questions.

There is currently a split between courts as to whether a discharge violation is also actionable under the FDCPA and other statutes. The Ninth Circuit holds that the bankruptcy discharge preempts other laws so that a plaintiff may not assert both causes of action. Walls v. Wells Fargo Bank, N.A., 276 F.3d 502 (9th Cir. 2002). On the other hand, the Seventh Circuit holds that one federal statute cannot preempt another and that implied repeal of another federal statute should not be done on less than imperative grounds. Randolph v. IMBS, Inc., 368. F.3d 726 (7th Cir. 2004). Judge Clark sided with the Seventh Circuit, finding that both federal causes of action could be asserted simultaneously. However, he went one step further and found that the state causes of action were not preempted either.

However, what is really interesting about this opinion is that Judge Clark also ruled that he had jurisdiction to consider all of the claims in one action. In doing so, he disagreed with Judge Clark. In Mahoney v. Washington Mutual , Judge Clark dismissed state law claims which arose from the same facts as an alleged discharge violation because they did not have any conceivable effect on the bankruptcy estate. In so ruling, Judge Clark followed the test for “related to” jurisdiction which has long been followed in the Fifth Circuit.

So, why did Judge Clark disagree with Judge Clark? The difference was an intervening Fifth Circuit decision. In Matter of Morrison, 555 F.3d 473 (5th Cir. 2009), the Fifth Circuit upheld a decision by a bankruptcy court which held a debt to be nondischargeable and entered a money judgment on the claim. The Fifth Circuit found that judicial efficiency should not require a creditor obtaining a finding of nondischargeability to file a separate action to obtain a judgment on the claim. Judge Clark found that the same logic applied in this situation as well. He said:

A similar rationale warrants a similar exercise of jurisdiction here. The action for violation of the discharge injunction is a core proceeding, one that arises under a provision of title 11. (citation omitted). The selfsame facts make out a case for violation of the FDCPA. There would be no judicial efficiency in requiring the beneficiary of a judgment finding the defendant liable for violating the discharge injunction to pursue a separate lawsuit in state or federal court in order to secure a money judgment against the defendant. (citation omitted). Thus, the court concludes, under the reasoning of Morrison, that it has the requisite subject matter jurisdiction to entertain the FDCPA cause of action.

Eastman, at 8.

If Judge Clark is correct, “related to” jurisdiction has substantially expanded in the Fifth Circuit. If a Bankruptcy Court has jurisdiction over a claim, then it also has jurisdiction over other claims arising from the same facts in the name of judicial efficiency. This conclusion is somewhat of a two-edged sword. On the one hand, it expands the Bankruptcy Court’s jurisdiction to include what would be known as supplemental jurisdiction for an Article III Court. However, it also undermines the ability of a plaintiff to pursue separate bankruptcy and state court claims arising from the same facts on the ground that the bankruptcy court lacked jurisdiction to hear the non-bankruptcy claims.

His English Teacher Would Be Proud

Many of us forgot the formal rules of grammatical construction as fast as we could, but not Justice Breyer. In an opinion today, he delivered a grammatical tour de force.

There are strong textual reasons for rejecting the Government’s position. As a matter of ordinary English grammar, it seems natural to read the statute’s word “knowingly” as applying to all the subsequently listed elements of the crime. The Government cannot easily claim that the word “knowingly” applies only to the statutes first four words, or even its first seven. It makes little sense to read the provision’s language as heavily penalizing a person who “transfers, possesses, or uses, without lawful authority” a something, but does not know, at the very least, that the “something” (perhaps inside a box) is a “means of identification.” Would we apply a statute that makes it unlawful “knowingly to possess drugs” to a person who steals a passenger’s bag without knowing that the bag has drugs inside?

The Government claims more forcefully that the word “knowingly” applies to all but the statute’s last three words, i.e., “of another person.” The statute, the Government says, does not require a prosecutor to show that the defendant knows that the means of identification the defendant has unlawfully used in fact belongs to another person. But how are we to square this reading with the statute’s language?

In ordinary English, where a transitive verb has an object, listeners in most contexts assume that an adverb (such as knowingly) that modifies the transitive verb tells the listener how the subject performed the entire action, including the object as set forth in the sentence. Thus, if a bank official says, “Smith knowingly transferred the funds to his brother’s account,” we would normally understand the bank official’s statement as telling us that Smith knew the account was his brother’s. Nor would it matter if the bank official said “Smith knowingly transferred the funds to the account of his brother.” In either instance, if the bank official later told us that Smith did not know the account belonged to Smith’s brother, we should besurprised.

Of course, a statement that does not use the word “knowingly” may be unclear about just what Smith knows. Suppose Smith mails his bank draft to Tegucigalpa, which (perhaps unbeknownst to Smith) is the capital of Honduras. If the bank official says, “Smith sent a bank draft to the capital of Honduras,” he has expressed next to nothing about Smith’s knowledge of that geographic identity. But if the official were to say, “Smith knowingly sent a bank draft to the capital of Honduras,” then the official has suggested that Smith knows his geography.

Flores-Figeroa v. United States, No. 08-108 (U.S. 5/4/09).

Justice Alito, who was also paying attention in English class, wrote separately to express his opinion on how the word knowingly should be used.

While I am in general agreement with the opinion of the Court, I write separately because I am concerned that the Court’s opinion may be read by some as adopting an overly rigid rule of statutory construction. The Court says that “[i]n ordinary English, where a transitive verb has an object, listeners in most contexts assume that an adverb (such as knowingly) that modifies the transitive verb tells the listener how the subject performed the entire action, including the object as set forth in the sentence.” Ante, at 4. The Court adds that counterexamples are “not easy to find,” ante,at 5, and I suspect that the Court’s opinion will be cited for the proposition that the mens rea of a federal criminal statute nearly always applies to every element of the offense.

I think that the Court’s point about ordinary English usage is overstated. Examples of sentences that do not conform to the Court’s rule are not hard to imagine. For example: “The mugger knowingly assaulted two people in the park—an employee of company X and a jogger from town Y.” A person hearing this sentence would not likely assume that the mugger knew about the first victim’s employer or the second victim’s home town. What matters in this example, and the Court’s, is context.

More to the point, ordinary writers do not often construct the particular kind of sentence at issue here, i.e., a complex sentence in which it is important to determine from the sentence itself whether the adverb denoting the actor’s intent applies to every characteristic of the sentence’s direct object. Such sentences are a staple of criminal codes, but in ordinary speech, a different formulation is almost always used when the speaker wants to be clear on the point. For example, a speaker might say: “Flores-Figueroa used a Social Security number that he knew belonged to someone else” or “Flores-Figueroa used a Social Security number that just happened to belong to a real person.” But it is difficult to say with the confidence the Court conveys that there is an “ordinary” understanding of the usage of the phrase at issue in this case.

While Flores-Figeroa is a criminal opinion, it pays to be in the know about how to construe knowingly in bankruptcy court as well. I hope that these excerpts make everything perfectly clear.

Chrysler Seeks the Ultimate 363 Sale as the Treasury Department Dictates the Pace

Chrysler, LLC filed for chapter 11 bankruptcy on April 30 with the United States Treasury firmly in the driver’s seat (pun intended). In its first day filings, Chrysler announced that it would be seeking $4.5 billion in DIP financing from the Treasury and that it intended to affect a sale of substantially all of its assets to a newly created entity within 60 days. The U.S. Treasury filed a statement concurring in the filing and noting that its commitment to provide DIP financing was conditioned on timely filing and approval of the motion for sale of assets free and clear of liens.

Chrysler’s Woes

According to Chrysler’s filings, it is “one of the most agile and innovative car manufacturers in the world” whose name is “synonymous with innovative engineering” and whose liquidation “would have significant adverse impacts on the nation’s economy.” However, the filings also show (or at least imply) that the company took on too much debt in a leveraged buyout, failed to keep up with technology and mortgaged its future to payment of employee benefits.

While Chrysler bills itself as “the quintessential American automobile company,” its present difficulties as well as its plan for recovery arise from European alliances. In 1998, Chrysler merged with German automaker Daimler-Benz. At the time, the company was healthy and had cash reserves of $7.5 billion. The German alliance didn’t work out and Chrysler went private in a leveraged buyout in 2007. As part of this transaction, Chrysler incurred $10 billion in first lien debt (which has been paid down to $7 billion). According to Chrysler, this first lien debt is now trading at 15 cents on the dollar. It also incurred $2 billion in second lien debt from affiliates of its shareholders, including $1.5 billion from Daimler Financial. When Chrysler encountered financial difficulty last year, it received $4 billion in TARP funds from the U.S. Treasury, which are secured by a third lien. In addition to these secured debts, Chrysler owes $5.4 billion in trade debt, $1 million on its Amex cards and is required to spend $6.7 billion for settlement of claims relating to employee health care benefits. As will be discussed later, Chrysler's exit strategy in this case involves an alliance with Fiat.

Beginning in February 2007, the company began paring down its offerings to those which had the best sales and margins. Three of those identified in this class were the Jeep Grand Cherokee, the Dodge Ram truck and the Chrysler Town & Country minivan. All of these were large and not very fuel efficient. The implication is that Chrysler doesn't do so well in the market for fuel efficient cars, an impression reinforced by Chrysler's statements about the benefits of obtaining small car technology from Fiat.

According to Chrysler, it was hit hard by the financial crisis in the fall of 2008. When the market for securitizations imploded, there was no longer a means to sell auto loans to obtain new capital. Additionally, with the economy in free fall, people stopped buying vehicles. Chrysler points to sales in January to March of 2009, which were 35-37% below sales during the same months in 2008. In December 2008, Chrysler idled its plants for one month (with some staying closed longer).

One requirement of accepting the TARP money (which Chrysler notes that “many other large corporate pillars of the economy” requested), was that Chrysler had to submit a Viability Plan to the government and show its progress in meeting certain benchmarks. The government told Chrysler that it would support its working capital needs up through April 30 and required it to negotiate agreements with its creditors, the UAW and its proposed partner Fiat within this time. Chrysler reports that it reached the required agreements with almost all constituencies and filed bankruptcy on April 30 to implement the plan.

The Proposed Sale

While Chrysler paints a glowing picture of the progress it has made in negotiating with stakeholders, the U.S. Treasury has indicated that it is holding a gun to the company’s head and requires a sale to be approved and closed within 60 days. According to a statement released on behalf of Acting U.S. Attorney for the Southern District of New York Lev Dassin:

The President has made clear that the United States cannot commit to fund Chrysler if the company’s restructuring lacks a realistic probability of success. Treasury cannot and will not make an open-ended commitment to Chrysler for billions of dollars more, especially in light of the myriad other meritorious, competing demands for the public’s resources; its commitment to fund Chrysler’s bankruptcy must be contingent on Chrysler achieving the milestones necessary to close a sale in sixty days. Simply put, this time period for a sale is a necessary and critical condition to government funding.

Statement of the United States Department of the Treasury in Support of the Commencement of Chrysler, LLC’s Chapter 11 Case, p. 5.

As a condition of providing DIP financing, the government has required that Chrysler adhere to the following schedule in selling its assets:

May 4: File 363 motion
May 9: Hearing to approve sales procedures
May 10: Have final and non-appealable order entered
May 20: Receive bids
May 29: In court auction
June 1: Hearing to approve sale
June 15: Entry of final and non-appealable order approving sale
June 27: Close the 363 sale.

If Chrysler fails to meet this timeline, the Treasury reserves the right to cut off funding and drive the company into liquidation.

The United States Treasury, in addition to being a pre-petition lender and post-petition lender is also a proposed equity holder in the stalking horse bidder. Under the proposed 363 motion, Chrysler’s operating assets will be transferred to New Chrysler of which the United States will be an 8% interest holder.

The proposed transaction consists of the following elements:

1. Chrysler will transfer substantially all of its operating assets to New Chrysler.
2. New Chrysler will assume” certain liabilities” of Chrysler and pay $2 billion in cash to Chrysler.

3. Fiat will contribute “to New Chrysler access to competitive fuel-efficient vehicle platforms, certain technology, distribution capabilities in key growth markets and substantial cost saving opportunities” (whatever that means).

4. New Chrysler will be owned 55% by a Voluntary Employees Beneficiary Association, 8% by the United States, 2% by Canada and 20% by Fiat (with the right to increase its stake to 51%).

Although $2 billion is to be paid to Chrysler, it states that it anticipates that no cash will remain in the company. Instead, the company will be left with eight manufacturing plants which are not being transferred.

The documents filed so far are somewhat vague about which “certain liabilities” will be assumed. However, Chrysler’s declaration does state that the company’s largest first lien creditors, JP Morgan Chase, Goldman Sachs, Morgan Stanley and Citigroup, have agreed to write off 70% of their debt and that the $2 billion in second lien debt owed to Chrysler’s shareholders, Daimler Financial and Cerberus Capital, will be forgiven. The shareholders will also be required to fund hundreds of millions of dollars in pension liabilities. It does not expressly say what will happen to the U.S. government's third lien debt or the company's trade debt.

Implications

This is certainly an unprecedented case. However, the extent to which the United States is directing the outcome of the proceeding raises some major issues.

First, is this a sub rosa plan? The Second Circuit has held that sub rosa plans cannot be part of a Section 363 sale. In re Iridium Operating, LLC, 478 F.3d 452 (2nd Cir. 2007) (“The trustee is prohibited from such use, sale or lease if it would amount to a sub rosa plan of reorganization. The reason sub rosa plans are prohibited is based on a fear that a debtor-in-possession will enter into transactions that will, in effect, "short circuit the requirements of Chapter 11 for confirmation of a reorganization plan.").

The proposed sale transaction looks like it is rearranging the priorities of creditors, which would be a clear sign of a sub rosa plan. Based on what has been disclosed so far, first lien holders will receive only 28% of their claims and second lien holders will receive nothing. However, nothing is said about the third lien held by the United States or the trade creditor claims. Allowing junior claims to participate without payment in full of senior claims is a clear violation of the absolute priority rule unless the parties vote in favor of the plan. Since there is no voting on a sale, how can this consent take place?

Additionally, the sale motion essentially dictates the post-reorganization ownership of New Chrysler, allocating it between employee benefits, the United States and Canadian governments and Fiat. Dictating who will own the reorganized debtor is another sure sign of a sub rosa plan. Some clever lawyering was used to try to avoid this problem. The 363 motion will not dictate that the company is sold to New Chrysler, only that it will be the stalking horse bidder. However, given the extremely short time frame dictated by the U.S. Treasury, there is no meaningful opportunity for outsiders to bid.

There are also some very interesting separations of power issues. Typically, a bankruptcy judge would not allow a DIP lender to dictate that all of the company’s assets be sold within 60 days. However, in this case, the President of the United States, acting through the Treasury Department is the one dictating the result. Should the judicial branch defer to the executive branch in this instance or should the court be free to say no to the President. This one is easily answered. The Bankruptcy Judge can veto the Treasury Department’s terms for post-petition lending, but cannot force the Treasury Department to lend. Thus, the Judge must decide whether he is willing to take the responsibility for killing Chrysler. While this is an unfair burden to place on a judge, he is still free to act.

The other interesting question is how the U.S. Trustee can be an effective watchdog for the case when the President and the Treasury Department are potentially overstepping their bounds in directing how the case will proceed. Technically, there are separate lines of authority, since the Treasury Department is appearing through the U.S. Attorney and the U.S. Trustee is part of the Justice Department. However, they are both part of the United States executive branch with the President at the top. In a lower profile case, this might not be a problem. However, in a case of this magnitude, it seems like the U.S. Trustee is placed in a no win situation. However, I am not aware of any provision which allows someone outside of the executive branch to step in for the U.S. Trustee in the event of a conflict.

It will be interesting to see how Judge Gonzales and the U.S. Trustee navigate this minefield.

The Human Face of Bankruptcy

This week I received an unhappy call from the wife of a debtor whose case I had written about. Although the article was posted nearly two years ago, someone had recently told her that her husband's name was mentioned on the internet. She found this very distressing. I tried to explain to her that I was merely reporting on a published opinion by a United States Bankruptcy Judge. In the background, her husband was telling her that I could not use his name without permission and that I was just trying to make money from my blog (neither one of which was true). She insisted that her husband had done nothing wrong notwithstanding the judge's ruling to the contrary.

In the end, I decided to redact the article to remove the name of the debtor and replace it with "Name Withheld by Request." I was not under any obligation to do this, since the debtor's name was part of a published opinion. However, she seemed so clueless about what had happened. She sincerely believed that everything which had happened in the case was the fault of the lawyers and the judge. She was very embarrassed that people in their small town could know about their problems. Although I had very little sympathy for the husband (who was found to have committed bad acts by Judge Bohm and who was very threatening in the background of the conversation), I did feel sorry for this very confused and embarrassed woman.

I don't know that I would do it again, because it is difficult to talk about cases without mentioning their names. However, it does point out that behind every case is a human being. When we talk about Marrama, Geiger and Cohen, these are not just Supreme Court cases, but also the names of individuals who have been immortalized in the case reporters. At the same time, I don't think that a lot of debtors fully comprehend the seriousness of what they are undertaking. As former Bankruptcy Judge Larry Kelly was fond of saying, "When you filed bankruptcy, you made a federal case out of it." Bankruptcy is a matter of public record and the unfortunate few who get their names mentioned in unfavorable written opinions will find that the memory of their deeds lives on in written pages and the increasingly on the internet.

While the name of this particular debtor is no longer mentioned on my blog, anyone can go to 366 B.R. 677 to read all about his case. I wonder if Mr. Name Withheld By Request will try to sue West Publishing for using his name without permission?