Benchnotes Jul/Aug 1998
Absolute Priority and Equity Interest
In In re Coltex Loop Central Three Partner L.P., 138 F.3d 39 (2d Cir. 1998), the chapter 11 debtor's plan of reorganization was confirmed by the bankruptcy court over the objection of the secured creditor, which then appealed the confirmation order. The district court reversed the confirmation order and, on appeal to the Second Circuit Court of Appeals, the district court was affirmed. The Second Circuit held that the debtor's cramdown plan, under which its equity holders would retain the debtor's primary asset in return for new capital, violated the absolute priority rule and, therefore, was not "fair and equitable." The debtor's primary asset was a 10-story office building in Houston, and the plan provided that the partners could contribute money to fund the plan in order to retain their equity interests. The plan sought to extinguish half of the secured creditor's debt and, apparently, there had been a lack of exposure of the property to the market and a lack of a fair opportunity for bids for the property from other parties. The district court found that the debtor had failed to establish that old equity's "new value" contribution was "necessary, because other avenues for funding a successful reorganization had not been adequately explored." Under the plan, old equity was the lender of "first opportunity," not the lender of last resort. Therefore, the district court found that old equity would receive its interest on account of its prior subordinate status, which violated the absolute priority rule. The question was "whether [debtor's partners] obtain or retain their interest in the debtor's property on account of their prior equity position or whether their retention of the real estate is on account of their new equity infusion." If the retention is "on account of their prior equity position," then the absolute priority rule is violated. If their retention is "on account of their new equity infusion," then the absolute priority rule is satisfied. "Based on the facts of this case, it is apparent that the partners could not have gained their new position but for their prior equity position." The partners would avoid foreclosure and obtain the property at a set price "untested by market forces, leaving the unsecured creditors with a 10 percent recovery. Where no other party seeks to file a plan (and in this case the secured creditor sought to file a plan which would have paid unsecured creditors 100 percent) or where the market for the property is adequately tested, old equity may be able to demonstrate that it can meet the requirements of 11 U.S.C. §1129 and that, in essence, it receives nothing on account of its prior position."
New Value Exception
In In re Dwellco I Ltd., 219 B.R. 5 (Bankr. D. Conn. 1998) Bankruptcy Judge Robert L. Krechevsky addressed competing plans of reorganization in what was essentially a single asset case. One plan was submitted by the debtor and the other by the undersecured, non-recourse creditor. The court initially addressed the debtor's plan and found that, in light of In re Coltex Loop Central Three Partners L.P., 138 F.3d 39 (2d Cir. 1998), the claim of a new value exception must be rejected as "new value" did not meet the "necessary" requirement. The debtor's new value was going to be used solely for the purpose of repairs and improvement to the property and would be "repaid" on a priority basis. The court held that such a "new value" was in essence an investment in the property, the benefit of which was solely for existing equity. The debtor also unsuccessfully challenged the creditor's plan, arguing that the secured creditor was unimpaired because the plan would give the property to the creditor, which was the "treatment it sought when it accelerated and attempted to foreclose on its lien." The court found the argument was groundless in that the creditor was impaired because it would use its cash collateral to pay administrative, tax, trade and employee wage and benefit claims.
In In re Texaco Inc., 218 B.R. 1 (Bankr. S.D.N.Y. 1998), the court considered a post-confirmation claims dispute that was the subject of a stipulation. The stipulation and order provided that the creditor's proof of claim and the debtor's (Texaco's) motion to expunge "shall be resolved and the claim shall be deemed allowed in such liquidated amount as is determined in the pending action outside the bankruptcy court by final order." Pursuant to the stipulation, the parties also agreed (and the court had previously ordered) that the "pending action will proceed as if no chapter 11 case had been commenced by Texaco." The parties also entered into an arbitration agreement. The court held that, pursuant to the arbitration agreement, the proof of claim and the pending action had merged and since "the stipulation and order mandated that the pending action proceed ‘as if no chapter 11 case had been commenced,'" the claim or defense of chapter 11 discharge was precluded. Thus, by agreement, the debtor lost the defense of the chapter 11 discharge in the combined litigation that included the claims objection.
Income Tax Benefits
In In re White Metal Rolling & Stamping Corp., 217 B.R. 981 (Bankr. S.D.N.Y. 1998), defendants moved for withdrawal of the reference on the grounds that the resolution of certain tax issues would require substantial and material consideration of federal tax law. The defendants were the parent and cor-porations related to the debtor. The issue was whether the debtor, as a subsidiary, had received adequate consideration for the use of its net operating losses (NOLs) by the defendants. The trustee sought to void alleged preferential and/or fraudulent transfers and to recover certain income tax benefits related to the debtor's net operating losses. The court held that "the bankruptcy court can decide whether the Tax Matters Agreement (an agreement among the affiliated companies) encom-passed the NOLs at issue here, and to what extent, if any, [debtor] received com-pensation either through the reduction of intercompany debt or as payments for tax benefits enjoyed by the [parent group], without the substantial and material consideration of non-bankruptcy law." The district court denied the motion to withdraw the reference.
Valuation and Redemption of Mobile Home
In In re Donley, 217 B.R. 1004 (Bankr. S.D. Ohio 1998), the chapter 7 debtors in their no-asset case attempted to redeem mobile homes for the sum of $10.00. The creditor opposed the motion and requested that the court determine the value of the mobile homes for redemption purposes. The bankruptcy court held that the replacement value standard for valuing retained collateral enunciated by the court in Associates Commercial Corp. v. Rash, 117 S.Ct. 1879 (1997), does not apply in the context of a redemption under a chapter 7 case and that the creditor's allowed secured claim should be valued instead by a standard that measures what the creditor would receive if redemption did not occur and the creditor were forced to repossess the property and then sell it in the most beneficial manner. In other words, what could the secured creditor expect to receive if it foreclosed on the collateral and then sold it? Based upon an analysis of the facts, the court permitted the redemption of the two mobile homes for the sum of $10.00.
Franchise Agreement Rejection
In In re Klein, 218 B.R. 787 (Bankr. W.D. Pa. 1998), the chapter 13 debtor operator of a Kwik-Kopy business, decided to reject the franchise agreement. The franchise agreement was controlled by provisions of §5.50 of the Texas Business & Commerce Code regarding enforceability of covenants not to compete. The debtor took the position that rejection of the contract rejected the covenant not to compete, and therefore the debtor was not bound by this covenant. The court held that while the debtor operated post-petition under the franchise agreement, the covenant not to compete was dormant and that only when the debtor rejected the contract and ceased operating under the franchise agreement did the covenant take effect, raising the questions of its applicability and enforceability. Since the effect of the covenant was not operative until the post-petition rejection, the court held that the obligation under the contract to pay royalties for breach of the covenant not to compete was a post-petition "actual and necessary expense to preserve the estate." As a result, the covenant was enforceable and the obligation to pay royalties was an administrative claim that had to be paid in full through the chapter 13 plan. The debtor could operate his business under a new name, but was enjoined from using the Kwik-Kopy name, logos, trademarks, etc., and from violating the non-compete.
Counterclaims After Rejection of Executory Contract
In In re Brown, 219 B.R. 373 (Bankr. E.D. Pa. 1998), the debtor brought a counterclaim to the proofs of claim filed by certain creditors in connection with a recording contract and a publishing contract, seeking to recover unpaid royalties. The debtor had filed a motion to reject the contracts within two days after the filing of the chapter 11 case. The court held that under 28 U.S.C. §157(b)(2)(C), counterclaims by the estate against creditors filing claims are core proceedings. The court also held that rejection of the contracts "did not adversely affect the debtor's right to prosecute his claims (for accounting and money damages) in this action, which are, for the most part, based upon his rights arising under the rejected contracts." Rejection of a contract "does not cut off the right of that debtor's estate to pursue a claim based on an alleged pre-petition breach of that contract."
Termination of Stay Sets De Facto Deadline on Assumption or Rejection
In In re El Paso Refinery L.P., 220 B.R. 37 (Bankr. W.D. Tex. 1998), Bankruptcy Judge Leif M. Clark held that termination of the automatic stay set a de facto deadline for the assumption or rejection of a fuel supply contract, thus giving the estate a short period of time (until the conclusion of the termination process provided for by the contract) within which either to assume or reject the contract. The failure of the estate to timely act resulted in a deemed rejection, which also gave the contracting agency a pre-petition unsecured claim for damages under the contract. The court allowed an unsecured claim of in excess of $1.9 million under the contract.
• In re Mallard Pond Ltd., 217 B.R. 782 (Bankr. M.D. Tenn. 1997) (although a limited payout term is not a per se indication that a plan is not feasible, the scrutiny of such a plan must be exacting);
• In re Ricci Inv. Co. Inc., 217 B.R. 901 (D. Utah 1998) (a bankruptcy professional's necessary and actual fees may be allowable in situations where the fees were unavoidably incurred, even if there was no benefit to the bankruptcy estate);
• In re Clark, 217 B.R. 943 (Bankr. M.D. Fla. 1998) (a debtor may avoid a lien pursuant to §522(f) even if discharge has been denied);
• In re Allen-Main Associates Ltd. Partnership, 218 B.R. 278 (Bankr. D. Conn. 1998) (non-recourse undersecured creditor cannot be sole petitioning creditor in involuntary chapter 7 case);
• In re Continental Airlines Inc., 218 B.R. 324 (D. Del. 1997) (creditor's right to setoff is extinguished by a confirmed chapter 11 or 13 plan unless the plan explicitly preserves such setoff right);
• In re Triangle Grain Co., 218 B.R. 523 (Bankr. E.D. Cal. 1998) (counsel for chapter 7 trustee is not entitled to be compensated from estate for defending trustee against claims of misconduct brought by the U.S. Trustee after the estate had been fully liquidated and the trustee's duties had been fully performed);
• In re Brown, 219 B.R. 191 (Bankr. 6th Cir. 1998) (section 1329 does not require unanticipated or substantial change as a pre-requisite to modification of confirmed chapter 13 plan);
• In re Start the Engines Inc., 219 B.R. 264 (Bankr. C.D. Cal. 1998) (bankruptcy court is not a "Court of the United States" and therefore lacks authority to award sanctions under 28 U.S.C. §1927 for unreasonably and vexatiously multiplying proceedings);
• In re Forbes, 218 B.R. 48 (8th Cir. B.A.P. - Mo. 1998) (two-year-old motion to dismiss chapter 13 case became moot when the debtor made his final payment under the plan and received a discharge);
• In re Feiler, 218 B.R. 957 (Bankr. N.D. Cal. 1998) (chapter 7 trustee could avoid as a fraudulent conveyance, debtor's election to carry back an NOL effectively disposing of its right to a current tax refund in exchange for the right to carry its NOL forward and use it to offset future income, despite that election's "irrevocable" nature under the federal tax laws);
• Hanna Coal Co. Inc. v. IRS, 218 B.R. 825 (Bankr. W.D. Va. 1997) (U.S. Dist. Ct., W.D. Va. 1997) (IRS violated stay and ordered to pay damages of $23,725.00 for the improperly sold equipment, plus attorneys' fees and costs where it had reason to know that equipment sold at auction to collect on a mining operation's delinquent employment taxes belonged to the chapter 11 debtor-equipment lessor);
• In In re Dragoo, 219 B.R. 460 (Bankr. N.D. Tex. 1998) (four-year suspension from practice of law in the Bankruptcy Court for the Northern District of Texas for filing objections to dis-chargeability of credit card debts without accomplishing service on debtors and then attempting to take default judgments);
• In re Larry Goodwin Golf Inc., 219 B.R. 391 (Bankr. M.D.N.C. 1997) (debtor that operated a golf course with associated golf cart rentals, a pool and concessions who owned adjacent land that was for sale was not a "single asset real estate" case under 11 U.S.C. §101(51B).