Delaware’s Bankruptcy Court has recently issued two insightful opinions that impact a creditor’s ability to establish the “receipt” element of a valuable 503(b)(9) administrative expense priority claim.

CASE 1: In re SRC Liquidation, LLC, Case No. 15-10541, 2017 WL 2992718 (Bankr. D. Del. July 13, 2017)

On July 13, 2017, Chief Judge Shannon of the United States Bankruptcy Court for the District of Delaware issued an opinion in the In re SRC Liquidation, LLC bankruptcy case regarding the ability of a creditor to assert a Section 503(b)(9) administrative claim for goods shipped by the vendor directly to a debtor’s customer in the 20 days before a debtor’s bankruptcy – referred to as “drop shipping.”

As discussed in prior posts on 503(b)(9) claims (Getting the Most Bang for Your 503(b)(9) Claims and Section 503(b)(9) Claims – What Does “Receipt” Really Mean?), to establish a 503(b)(9) claim, a creditor must demonstrate that:

  • goods were received by a debtor within 20 days before the petition date;
  • the goods were sold to the debtor; and
  • the goods were sold in the ordinary course of business.

The critical consideration in the SRC Liquidation decision was whether the creditor could establish that the debtor “received” the goods for purposes of establishing that its claim was entitled to administrative treatment pursuant to  Section 503(b)(9) of the Bankruptcy Code.  If not – the claim would be relegated to a non-priority, general unsecured claim (with little chance for recovery).  The creditor asserted that receipt occurred when the creditor-vendor delivered the product to a third-party shipper (UPS) for ultimate delivery to the debtors’ non-debtor customer.  By example, with most drop shipments, a debtor may directly place an order with a creditor-vendor, but the creditor-vendor may deliver the goods directly to a debtor’s customer, rather than the debtor itself.

In SRC Liquidation, the court’s analysis began with recognizing that “receipt” is not defined in the Bankruptcy Code and looking to the UCC for guidance.  Under the UCC, the term “receipt” can include physical possession (see § 2-103) or, in certain circumstances, constructive possession (i.e. § 2-705) when placed in the control of a bailee for the debtor.  The United States Court of Appeals for the Third Circuit in its recent opinion in In re World Imports, Inc., was also recently tasked with defining receipt for purposes of 503(b)(9) claims.  There, the Third Circuit, just days prior to Judge Shannon’s SRC Liquidation decision, held that receipt for purposes of 503(b)(9) claims required physical possession – and the Third Circuit looked to both its prior precedent in the case of Montello Oil Corp. v. Marin Motor Oil, Inc. (In re Marin Motor Oil, Inc.), 740 F.2d 220 (3d Cir. 1984) (where receipt for reclamation purposes was found to require physical possession) and the UCC.  The Third Circuit in In re World Imports, Inc. also noted that in analyzing shipping arrangements, placement of the goods into the possession of a common carrier (who was not the debtor’s bailee) did not establish “receipt” –instead observing it occurred when the debtor physically received the goods.

The creditor in In re SRC Liquidation argued that receipt for purposes of 503(b)(9) should be interpreted to include constructive receipt – including by a debtor’s customers.  The creditor argued that the court should interpret the term “received” differently when considering it under 503(b)(9) as opposed to reclamation because the commercial realities and the remedies are different.  The creditor argued that for reclamation, because the remedy is recovery of actual goods delivered, physical possession of the goods would understandably be a prerequisite, while in contrast for a 503(b)(9) claim, a creditor is asserting a claim for the value of the goods – not for the actual goods – and thus constructive possession should be permitted.  A focal point of the creditor’s argument was that “receipt” for 503(b)(9) purposes should be determined when title passed from the seller – i.e. when placed with the third-party shipper.

The bankruptcy court disagreed finding that the term “received” should mean the same for reclamation as for 503(b)(9) purposes because they arise in similar circumstances and concern related issues.  The court further held that the passing of title was not the only concern – particularly under the UCC – for establishing rights of buyers and sellers – noting that “possession is the key.”   Judge Shannon cited the Third Circuit’s decision just days in In re World Imports, Inc.   My recent prior post provides a more in-depth analysis of that decision, where the Third Circuit held that physical possession by the debtor was determinative of whether the debtor “received” goods for 503(b)(9) purposes, as opposed to the when title or of loss of product passed.    

Judge Shannon’s decision was not appealed and appears to follow the majority of other courts that have addressed the drop shipment issue (including Judge Shannon’s prior findings in the SRC case).  The majority of courts hold that unless the actual debtor-customer (as opposed to another party) received the goods, the claim for such goods is not entitled to administrative expense priority treatment under Section 503(b)(9) of the Bankruptcy Code.  See, e.g., In re SRC Liquidation Co., No. 15-10541(BLS) (Bankr. D. Del. Oct. 15, 2015) (transcript of bench ruling) (“[W]hile it may be a business relationship developed of long practice and, frankly, for the benefit and at the direction of the Debtor, nevertheless, the circumstances of that business relationship and the way product was moved from one party to another is such that it takes it outside of the scope of Section 503(b)(9).”); In re Plastech Engineered Prods., Inc., No. 08-42417, 2008 WL 5233014, at *1 (Bankr. E.D. Mich. Oct. 7, 2008) (sustaining debtors’ objection to 503(b)(9) claim for goods delivered directly to debtor’s customer); Ningbo Chenglu Paper Prods. Manuf. Co., Ltd. v. Momenta, Inc. (In re Momenta, Inc.), No. 11-cv-479-SM, 2014 WL 3765171, at *7 (D.N.H. Aug. 29, 2012) (same).  The ultimate implication of this ruling is best considered in the context of the In re ADI Liquidation, Inc., et al. decision issued in June 2017 and discussed below.

CASE 2: In re ADI Liquidation, Inc., et al., Case No. 14-12092, 2017 WL 2712287 (Bankr. D. Del. June 22, 2017)

Last month, on June 22, 2017, Judge Carey of the United States Bankruptcy Court for the District of Delaware issued an opinion in the In re ADI Liquidation, Inc., et al. cases addressing what “received” means in the context of a Section 503(b)(9)  claim derived from a wholesale arrangement – which he analogized to a drop shipment arrangement.   Wholesale/cooperative arrangements are prevalent in and outside of the grocery industry.  In cooperatives, typically member-participants collectively order through a centralized billing system and typically the orders are all made by and through one entity to vendors (and that entity also pays for the goods), but the shipments are often made directly to the member-participants (as opposed to the ordering party), who then pay the ordering party after the fact.  Cooperatives often arise where buyers, who purchase the same products or purchase from the same vendors, pool their buying power to negotiate more favorable rates.

In the ADI Liquidation case, creditor Bimbo Bakeries USA, Inc. (“BBU”) supplied baked goods to AWI (f/k/a Associated Wholesalers, Inc.) and to its cooperative members (which included non-debtor entities).  The ordered goods were delivered directly to AWI as well as directly to the non-debtor cooperative members.  AWI would typically pay vendors for all of the purchased goods (by both AWI and its cooperative members).  There was a separate purchase and supply agreement between the members and AWI, pursuant to which AWI acted as a wholesaler to the members.  BBU as a vendor was not a party to the purchase agreement.

When BBU asserted its Section 503(b)(9) claims, it included goods delivered directly to debtor AWI and goods that BBU delivered to the non-debtor AWI Members (that were ordered and paid for by AWI).  As discussed above and in my prior posts on 503(b)(9) claims, to establish a 503(b)(9) claim, a creditor must demonstrate, among other things, that the goods were received by a debtor within 20 days before the petition date.

The central focus of the court’s opinion in In re ADI Liquidation was whether or not BBU established that the AWI debtors “received” the goods that BBU delivered to the non-debtor cooperative members.  BBU argued that the goods in question were constructively received by debtor AWI (and thus entitled to administrative expense treatment under Section 503(b)(9) because debtor AWI and the non-debtor receiving members/customers were so related and indivisible, that the receipt by the customer was the equivalent of the debtor receiving it.  The court’s instant decision did not address BBU’s other claims – including administrative expense claims for goods delivered to other debtors, but ordered by AWI.

Recognizing (as referenced above) that the term “received” is not defined by the Bankruptcy Code, the court looked to the UCC for guidance and found that for constructive receipt to be established (often considered in the context of reclamation), the receiving party must be a bailee of the debtor.  The court held that the receiving members were not bailees of debtor AWI and notwithstanding that the UCC contemplates that constructive receipt can occur by a buyer-representative who is a “sub-purchaser” (like in a drop ship context), the court held that the “buyers” were the non-debtor members and not debtor AWI.  In so finding, the court determined that the claims for the goods that BBU delivered to the non-debtor members were non-priority, general unsecured claims (which would receive little, if any distribution).

On July 5, 2017, BBU appealed the Delaware Bankruptcy Court’s June 2017 decision to the District Court (assigned Case No. 17-903).   Given the prevalence of cooperative buying arrangements, in and outside of the grocery context, and the importance of “receipt” in establishing the very valuable 503(b)(9) claims, creditors and debtors alike will be carefully monitoring the developments of this case.

CONCLUSION

As discussed in prior posts, Section 503(b)(9) claims are very valuable to creditors (with the likelihood of providing a dollar for dollar return) as opposed to other general unsecured claims which often times provide speculative, if any, return.  These recent decisions on the receipt element for establishing a Section 503(b)(9) claim provide helpful guidance so that debtors, creditors and their respective professionals can better understand the prospects for establishing these administrative claims, and in particular for debtors, the cost of confirming a bankruptcy case – which requires payment in full for such claims.

In an era when goods or materials often originate from suppliers or manufacturers outside the United States, bankruptcy courts are grappling with when “receipt” of goods occurs for the purpose of 503(b)(9) claims.

While often times pre-petition claims receive only pennies on the dollar, Section 503(b)(b)(9) of the Bankruptcy Code provides creditors with an administrative expense claim for goods (not services) that a debtor receives in the 20 days before bankruptcy that often times results in a dollar-for-dollar recovery. Section 503(b)(9) is generally recognized as an alternative (and more desirable) remedy to reclamation rights – which are addressed under Section 546(c) of the Bankruptcy Code.

I previously addressed what steps to take to ensure that you are Getting the Most Bang for Your 503(b)(9) Bucks.  One of the pre-requisites to establishing entitlement to this valuable claim is demonstrating first that the debtor “received” the goods in question during the 20-day period.  An interesting issue arises in the context of “FOB” shipping arrangements.  “FOB” – or free on board – in the context of international shipping means that the buyer and seller agree at what point the risk of loss for the goods is shifted from the seller to the buyer – whether it is FOB destination (meaning it occurs upon delivery) or FOB shipping point/origin (meaning it occurs when the goods are placed on the ship in the port of origin).

Why does this matter? Because – as addressed in last week’s opinion by the United States Court of Appeals for the Third Circuit in In re World Imports, Ltd., et al., — F.3d —-, 2017 WL 2925429 (3d Cir. July 10, 2017), No. 16-1357, creditors may use FOB origin to ship to a debtor.  The goods may be placed on a ship outside the 20-day period, but the debtor receives the goods (i.e., in-hand physical possession) within the 20-days.  The question becomes when are the goods “received” for the purpose of establishing the very valuable Section 503(b)(9) claim:  if outside the 20-day period, there is often little, if any, potential for a meaningful recovery, but if within the 20-day period, and provided the other elements of Section 503(b)(9) are met, a creditor can obtain a dollar-for-dollar recovery for those goods.

“Receipt” is not defined by the Bankruptcy Code.  The Third Circuit and the 2 lower courts from which the Third Circuit appeal emanated addressed what “receipt” in the context of an FOB origin arrangement means for establishing a Section 503(b)(9) claim.

The Bankruptcy Court for the Eastern District of Pennsylvania held in favor of the debtor and its Official Committee of Unsecured Creditors, finding that in an FOB origin arrangement, “receipt” of goods occurs at the point of origin when the goods were placed on the ship (which was outside the 20-day period), and when title and risk of loss of goods shifted to the debtor.  See, In re World Imports, Ltd., 511 B.R. 738 (Bankr. E.D. Pa. 2014).  This determination was affirmed by the District Court.  See In re World Imports, Ltd., 549 B.R. 820 (E.D. Pa. 2016).  The lower courts each rejected the creditors’ arguments that the courts should look to state law, i.e., the UCC definition of “receipt” – which requires the customer’s physical possession of the goods, looking instead to an international treaty, the Convention on Contracts for the International Sale of Goods (as adopted by the United States) (“CISG”), finding it created an exception.  Although “receipt” is also not defined in the CISG, it recognizes international commercial terms – like FOB, which provide for the transfer of risk of loss/damage to goods at the time the goods are placed on the ship. The lower courts both found that this transfer of title and risk was determinative of “receipt” for purposes Section 503(b)(9).

On July 10, 2017, however, the Third Circuit in In re World Imports, Ltd. reversed the lower courts, finding that receipt did not occur until the goods were physically in the debtor’s possession, which occurred within the 20-day period, enabling the creditors to succeed in meeting the prerequisite element that the goods were “received” within the 20-day period as required by Section 503(b)(9).  The Third Circuit began its analysis with examining the definition of “receipt.”  The Third Circuit considered how the UCC defines “receipt” – as well as Black’s dictionary and how the Third Circuit previously interpreted the term in the context of Section 546(c) of the Bankruptcy Code – the provision governing reclamation – all of which required physical possession. See, e.g., In re Marin Motor Oil, 740 F.2d 220, 224-25 (3d Cir. 1984).

Given the relationship between Section 503(b)(9) and the reclamation scheme (noting that 503(b)(9) is an exemption to that scheme), and the Third Circuit’s standing precedent that “receipt” in the context of reclamation requires physical possession, the Court found that “receipt” for Section 503(b)(9) also required “taking physical possession.”  In so finding, the Third Circuit dismissed arguments that “constructive receipt” under the terms of FOB origin shipping should determine “receipt” for bankruptcy purposes.  A key element to this finding was the Third Circuit’s prior determination that a carrier (like the ship) does not serve as a debtor’s agent for purposes of “receipt.”  See In re Marin Motor Oil, 740 F.2d at 222.  Notably, the Third Circuit in its prior decision in In re Marin Motor Oil, supra, addressed “constructive receipt” finding that “constructive receipt” occurred when the debtor’s agent took physical possession of the goods from the common carrier – not (the day prior) when the seller placed the goods in the hands of the common carrier.  Id.

The Third Circuit also based its decision on the UCC’s explicit distinction of “receipt” and “delivery – observing that while a supplier may be contractually obligated to “deliver” goods, that does not necessarily mean a buyer receives them – and that delivery and receipt can occur at two separate times.  Moreover, given its recognition that Section 503(b)(9) and the reclamation scheme under the Bankruptcy Code have generally borrowed from the definitions of the UCC, the Court did not believe it appropriate to look to other federal law, e.g. the CISG, for contextual meaning, as there was no explicit connection in that definitional scheme to that of the Bankruptcy Code.

Ultimately, and notwithstanding that parties may, in fact, contract for title and risk of loss to pass to a debtor-buyer days prior and in another country – “receipt” for Section 503(b)(9) does not occur until the goods are physically in a debtor’s possession.  The Third Circuit reversed and remanded to the lower court for further proceedings to permit the claims to receive the favored administrative status.

This issue may arise in a number of contexts – including domestically.  Creditor-vendors are well-advised to carefully examine the underlying facts in preparing their claims.  While establishing “receipt” is just one facet of proving your Section 503(b)(9) claim, the Third Circuit’s recent decision adds color and context for creditors to better understand how to establish these valuable administrative claims. This recent decision may enable a larger number of creditors to assert administrative expense claims against a debtor’s estate.  This will also necessarily increase a debtor’s administrative expenses where the debtor relies on goods or materials shipped from overseas, which may negatively impact a debtor’s ability to successfully emerge from bankruptcy.

Court: “You know, every piece of information and fact out there is within six degrees of separation of the debtors’ assets and financial affairs. The question is where do you draw the line?”

4/20/17 Transcript of hearing in In Re SunEdison, Inc., et al, Case No. 16-10992-smb (hereinafter “TR”), page 30 lines 6-11.

The Issue.  An issue of first impression appears to have arisen recently in a case pending before United States Bankruptcy Judge Stuart Bernstein in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). In the Chapter 11 Case, In re: SunEdison Inc., et al., 16-10922 (SMB) (the “Debtors”), the Bankruptcy Court directed supplemental briefing on the question of whether a debtor is entitled to Bankruptcy Rule 2004 discovery into non-debtor litigation, because the outcome of that litigation may have an effect on the value of a significant asset of the bankruptcy estate of the Debtor. At the hearing where the issue arose, the Bankruptcy Court noted that it had been unable to find a case directly on point, and at the hearing the parties to the matter were not able to identify any such cases.  Spoiler alert—as of the date this blog was prepared, the Bankruptcy Court had not yet ruled; an update will be provided when it does so. While we hold our breath waiting for the Bankruptcy Court’s ruling, here is the background and where the six degrees of separation fit in (further spoiler alert: here, the six degrees of separation have nothing to do with Kevin Bacon).

Background: The debtor, SunEdison, Inc. (“SunE”) commenced its chapter 11 case on April 21, 2016, together with twenty-five affiliated co-debtor entities, with additional affiliated co-debtors thereafter filing voluntary petitions  (collectively, the “Chapter 11 Cases”). The Chapter 11 Cases have been consolidated for procedural purposes only and are being jointly administered.  Notably absent from the Chapter 11 filings were two entities that are referred to in the Chapter 11 Cases as the non-debtor publicly traded “YieldCo” subsidiaries of SunE, TerraForm Power, Inc. (“TERP”), and TerraForm Global, Inc. (“GLBL,” and together with TERP, the “YieldCos”). According to SunE, SunE holds a majority equity stake in TERP and approximately 33% equity stake in GLBL.

In 2014, SunE and TERP, as buyers, had entered into a contract to purchase from D.E. Shaw Composite Holdings, L.L.C. (“DESCO”) and Madison Dearborn Capital Partners IV, L.P. (“MDP” and, together with DESCO, “Plaintiffs”) a company named First Wind, an energy company that owned and developed wind and solar energy. Thereafter a dispute arose and on April 3, 2016, prior to the commencement of the Chapter 11 Cases, Plaintiffs filed a lawsuit in New York Supreme Court against TERP seeking a declaratory judgment as to TERP’s obligations (the “First Wind Litigation”). The Debtors are not a party to that litigation.  Upon SunE declaring bankruptcy in April 2016, Plaintiffs asserted that an acceleration event had occurred, and Plaintiffs filed an amended complaint in State Court asserting a claim for breach of contract for TERP’s failure to make what Plaintiffs assert is a $231 million in the aggregate “Accelerated Earnout Payment” as one of the two buyers under the purchase agreement, and for TERP’s failure to comply with its obligations as guarantor.

The Rule 2004 Motion and the Debtors’ Position.  In a motion filed jointly by the Debtors and TERP ( the “Rule 2004 Motion”), they sought the entry of an order of the Bankruptcy Court pursuant to Bankruptcy Rule 2004 seeking the production of documents by Plaintiffs and reserving the right to seek depositions[ Docket No. 2692].

According to the Debtors, on March 6, 2017, TERP and Brookfield Asset Management Inc. and its affiliates (“Brookfield”) entered into a definitive agreement under which Brookfield agreed to acquire a controlling interest in TERP (the “Brookfield Acquisition”), with SunE retaining a minority equity interest.  Pursuant to this transaction, the Debtors asserted that the Debtors’ estates stood to realize in excess of $800 million in cash and TERP equity and that, accordingly, the disposition of TERP is “critically important” to the formulation of a plan of reorganization of the Debtors, as well as to the proceeds available for distribution to secured and unsecured creditors of the estates.  Although the Brookfield Acquisition is not contingent upon resolution of Plaintiff’s claim against TERP, any liability with respect to these claims would, said the Debtors, reduce the value of the equity in TERP retained by SunE after the Brookfield Acquisition. The Debtors further contend that (a) uncertainty about the nature or magnitude of these claims could therefore complicate the financing and implementation of the Debtors’ plan of reorganization, which is premised, in part, on the value of the Debtors’ retained TERP equity; and, in addition, (b) the Brookfield Acquisition is subject to approval by TERP’s public stockholders, and the strength of Plaintiff’s claims against TERP may potentially be important to them.

The discovery is necessary, said the Debtors and TERP, so that SunE and TERP would be able to mitigate any concerns that SunE’s financing sources and TERP’s stockholders may have about the claims of Plaintiffs.  Also, contended Debtors and TERP, the discovery would demonstrate that Plaintiff’s claims against TERP were not colorable, on the basis that the First Wind Action depended entirely on Plaintiff’s interpretation of an ambiguous clause of the 2014 purchase agreement that parol evidence would not support. According to the Debtors, without discovery, Plaintiffs would be in a position to interfere with the Brookfield Acquisition and its benefits to SunE and TERP stakeholders.

Plaintiffs’ Initial Objection.  In their initial objection to the Rule 2004 Motion, Plaintiffs argued that the Rule 2004 Motion should be denied as a flagrant violation of the “pending proceeding” rule prohibiting the use of Rule 2004 to obtain or circumvent discovery in pending litigation. There was, argued Plaintiffs, no uncertainty about the nature or magnitude of Plaintiffs’ claims as the 2004 Motion alleges, the claims for breach asserted in the First Wind Litigation were unambiguous, and TERP failed to take discovery in the First Wind Litigation in the State Court.  Furthermore, according to Plaintiffs, the requested Rule 2004 discovery should also be rejected as wholly unnecessary for plan confirmation in the bankruptcy or in support of the Brookfield Acquisition [Docket No. 2783].

While Plaintiffs acknowledged that generally under Bankruptcy Rule 2004 a Bankruptcy Court may, on a motion, “order the examination of any entity” into “the acts, conduct, or property or to the liabilities and financial condition of the debtor, or to any matter which may affect the administration of the debtor’s estate,” Fed. R. Bankr. P. 2004(a)-(b), it argued that even Rule 2004 examinations have limits.  As argued by Plaintiffs, under the “Pending Proceedings” limitation, parties are precluded from obtaining discovery through Bankruptcy Rule 2004 when proceedings are pending in another forum, and under those circumstances courts have held that discovery should be pursued under the Federal Rules of Civil Procedure or equivalent procedures governing discovery in state court proceedings.

The Bankruptcy Court Hearing.   At the Bankruptcy Court hearing on the Rule 2004 Motion conducted on April 20, 2017, the Bankruptcy Court played devil’s advocate with both sides.  First, as to the Debtors, the Bankruptcy Court noted that in the Rule 2004 Motion, the Debtors did not really appear to seek discovery regarding the claims filed by the Plaintiffs in the Chapter 11 Cases, but, rather, the discovery was directed at non-debtor TERP’s liability to the Plaintiffs. On this point the Bankruptcy Court queried the Debtors’ counsel:

THE COURT: Let me ask you a question. Suppose that a debtor’s most important customer is involved in litigation outside of bankruptcy, and if it loses that litigation, the customer’s going to go out of business. Would a debtor have the right to get discovery from the other party in that litigation regarding the strength of that claim? Because that’s really what you’re saying.

TR page 26, lines 11-17.

The Court pressed the point by asking Debtors’ Counsel:

THE COURT: Let’s suppose you’re an individual Chapter 11 debtor and your most significant asset is Microsoft stock. Microsoft is involved in a patent litigation in Seattle with some third party, and the outcome of that action would affect the value of your stock. Do you think you could….
insist in bankruptcy court through [Rule] 2004 that that adversary has to turn over information so you can gauge the strength of its patent claim?….

TR page 27, lines 23-25; page 281-2, 8-10.

Six Degrees of Separation.  After colloquy with Debtors’ counsel regarding the propriety of a 2004 examination in connection with third party litigation (litigation to which the debtor was not a party) on the basis that the outcome of that litigation could have an effect on the value of the debtor’s assets, with counsel for the Debtors pressing that the examination is appropriate because it concerns the Debtors assets,  the Bankruptcy Court made the statement quoted at the beginning of this article: “You know, every piece of information and fact out there is within six degrees of separation of the debtors’ assets and financial affairs. The question is where do you draw the line?”

The Bankruptcy Court likewise played devil’s advocate with Plaintiffs’ counsel and queried why couldn’t the Debtors take Rule 2004 discovery to determine the value of its interest in TERP and on why the transaction with TERP should be approved.

Bankruptcy Court’s Preliminary Ruling and Request for Supplemental Briefing. Ultimately, the Bankruptcy Court denied the Rule 2004 Motion as to TERP on the basis of the Pending Proceeding Rule.  As to the Debtors, however, after the Bankruptcy Court noted that it had looked for but had not found any cases on point, the Bankruptcy Court provided the parties with additional time to respond to the Bankruptcy Court’s questions.

The Debtors’ Supplemental Response. In the Debtors’ supplemental response (the supplemental responses were filed simultaneously), they asserted that the broad examination of third parties concerning the value of a debtor’s assets, or to aid in discovery of assets, is permitted under Rule 2004.  In support, the Debtors cited several cases that permitted such discovery, including with respect to the value of a debtor’s stock in several third parties, and the value of a debtor’s interest in real property.  The Debtors further asserted that Plaintiffs qualified as potential examinees under Rule 2004, citing this language from In re Ionosphere Clubs, Inc., 156 B.R. 414, 432 (Bankr. S.D.N.Y. 1993): “Because the purpose of the Rule 2004 examination is to aid in the discovery of assets, any third party who can be shown to have a relationship with the debtor can be made subject to a Rule 2004 investigation.” The Debtors also pointed out that the Plaintiffs were not just any third parties, as they had filed proofs of claim that were the subject of the First Wind Litigation, and therefore the First Wind Litigation was related to the Chapter 11 Cases [Docket No. 2901].

The Plaintiffs’ Supplemental Response.   In the Plaintiffs’ supplemental response, the Plaintiffs contend that Rule 2004 does not support the broad application that the Debtors urge the Bankruptcy Court to adopt, that to the extent courts have permitted Rule 2004 examinations of third parties, the purpose of such examinations was not to assess the potential outcome of a third party litigation, and allowing a Rule 2004 examination in connection with the Third Wind Litigation would be an impermissible interference in a pending litigation to which the Debtors are not a party [Docket No. 2902].

Stay Tuned. Whether the Bankruptcy Court finds the supplemental responses were in fact responsive to the questions posed by the Bankruptcy Court, and were persuasive, remains to be seen.  We will follow up once a decision is rendered by the Bankruptcy Court.  Ideally, the decision will answer the question, at least in this Bankruptcy Court, of within how many degrees of separation does an issue need to be for it to be subject to examination pursuant to Bankruptcy Rule 2004.

Globalization has led to a marked increase in international components to insolvency proceedings.  Cross-border issues add a new layer of complexity to what is often a situation already fraught with obstacles.  Courts and practitioners alike face additional difficulties communicating with other courts, resolving issues consistently in jurisdictions with different laws and policy objectives, and enforcing rulings and implementing orders adjudicated extraterritorially.

Historically, coordination between courts of different jurisdictions was executed on an ad hoc basis—an uncertain, expensive, and time consuming process that potentially reduced the value of the business and recoveries of stakeholders.  Congress took note of the difficulty inherent with parallel insolvency proceedings, and in 2005, added Chapter 15 to the Bankruptcy Code.  Chapter 15 is a significant revision to its predecessor, section 304 of the Code, and addresses issues with the enforcement of insolvency proceedings rooted outside the United States.  However, the addition of Chapter 15 merely addressed some of the difficulties with cross-border insolvencies and only in the United States.  A larger, global resolution was yet to be had.

In October 2016, judicial officials from key commercial insolvency jurisdictions met at the first ever Judicial Insolvency Network conference to address the issues plaguing cross-border insolvency proceedings.  The solution they created was 14 guidelines, or best practices, as well as an annex on joint hearings (the “Guidelines”), all of which were crafted to aid courts and practitioners in cross-border insolvency cases.  In February 2017, the United States Bankruptcy Court for the District of Delaware (via Local Bankruptcy Rule 9029-2) and the United States Bankruptcy Court for the Southern District of New York (via General Order M-511) along with the Supreme Court of Singapore (via Registrar’s Circular No. 1 of 2017) moved the ball forward by adopting the Guidelines.

The Guidelines focus on three primary areas beyond their own implementation and interpretation: communication between courts, the process by which rulings are submitted for recognition between courts, and joint hearings.  The primary issue the Guidelines address is communication.  They establish the bounds of inter-court communication and help to resolve issues about the propriety of ex parte communication between courts. The ex parte communication the Guidelines list as appropriate is generally limited to the forwarding of court documents and clerical coordination between support staff.  Guidelines 7 and 8. However, when ex parte communication between courts may not be avoided and counsel is entitled to be present, those communications should be recorded and transcribed. Guideline 8(ii).  The primary purpose of this kind of communication is clear: to keep sister courts apprised of concurrent proceedings.

The Guidelines also anticipate joint hearings; that is, hearings conducted by video conference to limit the costs associated with conducting multiple proceedings for the same issue. Guidelines at Annex A.   Interestingly, the guidelines are entirely procedural—they specifically exclaim any effect on the substantive laws of their subscribing jurisdiction. Guideline 5.  So, while a hearing may be conducted in front of multiple courts at once, it is up to the practitioner to establish a sufficient record for each jurisdiction.

In this post-Stern opinion (the “Opinion”), the United States District Court for the District of Delaware (the “Court”) addresses two main issues with respect to the approval of nonconsensual third-party releases provided for in a chapter 11 plan of confirmation, namely whether a Bankruptcy Court has (1) subject matter jurisdiction to approve, and (2) the constitutional authority to grant such releases. Opinion at 2. The Court handed down its decision on March 17, 2017, over a year after the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) entered its order confirming Millennium Lab Holdings II, LLC, and its affiliated debtors’ (the “Debtors”) chapter 11 confirmation plan that contained such nonconsensual third-party releases. However, the decision is not, as one might had hoped for, a clarification as to whether a bankruptcy court has the authority to enter a final order approving such releases. Instead, recognizing that this is “far from ideal at this stage of the Chapter 11 proceedings,” the Court remanded the case to the Bankruptcy Court to give it an opportunity to address the issue of adjudicatory authority first.  Id. at 28.

Background

The Debtors’ chapter 11 plan provided, among other things, for a large contribution by non-debtor equity holders. Id. at 9. In exchange for the $325 million contribution, the plan contained certain nonconsensual third-party releases providing certain non-debtor equity holders “with full releases and discharges of any and all claims against them and related parties . . . . ”  Id. Importantly, the plan did not provide for an opt-out mechanism, therefore automatically, and regardless of whether creditors consented, granting the releases upon confirmation of the plan. Id. at 9-10.

Prior to the plan confirmation, certain pre-petition lenders (the “Appellants”) filed suit against the non-debtor equity holders alleging, among other things, fraud and violation of RICO claims. Id. at 10. The Appellants further objected to confirmation of the plan on multiple grounds. Id. They asserted, among other things, that the Bankruptcy Court lacked subject matter jurisdiction, and even if it had subject matter jurisdiction, it lacked the statutory authority to approve the third-party releases. Id. at 11.  After the Bankruptcy Court entered the order approving the chapter 11 plan on December 11, 2015, the Appellants filed an appeal raising several issues, but arguing primarily that “the release and permanent injunction of their direct, non-bankruptcy claims against non-debtors is a final order” prohibited by Stern and Wellness. Id. at 19-20.

A more detailed background of the Millennium Lab Holdings II, LLC, et al., bankruptcy cases and the history of the appeal can be found here.

Stern and Wellness

Before addressing the particularities of the case before it, the Court revisited the holdings of Stern and Wellness, two recent Supreme Court decisions that address the Bankruptcy Court’s jurisdictional authority.  Id. at 2-7 (citing Stern v. Marshall, 131 S. Ct. 2594 (2011); Wellness Int’l Network, Ltd. V. Sharif, 135 S. Ct. 1932, 1938-39 (2015)). The Court noted that these cases make “clear . . . that parties have a constitutional right to have their common law claims adjudicated by an Article III court, and [that] that right cannot be abridged by Congressional action.” Opinion at 3. The Court further noted that, “Article III imposes a structural limitation on the power of an Article I court to enter final orders or judgments on state law claims without the parties’ consent.” Id. at 2. The Court explained that Bankruptcy Courts “may ‘enter appropriate orders and judgments’ only in ‘cases under title 11’ and ‘core proceedings arising under title 11, or arising in a case under title 11.’” Id. at 3 (citing 28 U.S.C. Section 157(b)(1)).  In a non-core proceeding, that is “related to” a bankruptcy case, the Court clarified that the Bankruptcy Court’s authority, absent consent of the parties, is limited to hearing the matter and submitting proposed findings of fact and conclusions of law to an Article III District Court. Id. at 3-4.

Subject Matter Jurisdiction and Adjudicatory Authority Post-Stern

The Court, after briefly summarizing the law as to whether the permanent release of a non-debtor, third-party’s claim against another non-debtor third party falls under the purview of “related-to,” “arising in,” or “arising under” title 11 jurisdiction, the Court agreed with the Bankruptcy Court’s holding that such a release falls under the Bankruptcy Court’s “related-to” subject matter jurisdiction.  Id. at 4-5. However, having found that the Bankruptcy Court had subject matter jurisdiction did not end the inquiry for the Court. Id. at 19 (“The impact of Stern is that a finding of ‘related to’ subject matter jurisdiction under the statute does not end the inquiry.”). The Court held that “regardless of whether the Bankruptcy Court has subject matter jurisdiction over proceedings – both core and non-core – it cannot enter a final order releasing third-party claims unless it has constitutional authority to do so as well.” Id. at 7.

The critical question of adjudicatory authority, however, was not addressed by the Bankruptcy Court in its bench ruling confirming the Debtors’ chapter 11 plan. Id. at 14.  With respect to subject matter jurisdiction, Judge Silverstein noted:

The holding in Stern was meant to be a narrow one; one that does not, quote, “meaningfully change the division of labor between the Bankruptcy Court and the District Court.” To this end, debtors cite cases rejecting a Stern challenge, regarding the Bankruptcy Court’s constitutional authority to consider approval of third-party releases in a plan, including Judge Drain’s decision in MPM Silicones, but not any decision in this district. These Courts may be correct.  But because of the necessities of this case, I have not had time to address that argument.  But I need not do so, given my finding that I have related-to jurisdiction.  Having decided I have jurisdiction, I now turn to whether third-party releases are appropriate in this case . . . .

Id. at 14 (quoting 12/11/15 Bankruptcy Court Hr’g. Tr. at 15:23-16:11 [D.I. 206]).

As a result, the District Court, noting that “the Bankruptcy Court’s confirmation ruling . . . did not address whether the Bankruptcy Court lacked adjudicatory authority to enter a final order releasing those claims,” remanded the case to the Bankruptcy Court to, “given its experience and expertise, . . .  rule on this issue first.” Opinion at 14, 28.

On April 4, 2017, the Bankruptcy Court held a status conference and has requested briefing on the issue of constitutional authority in 45 days with an additional three-week reply deadline. See Vince Sullivan, Millennium to Brief Court on Creditor 3rd-Party Releases, Law360 (Apr. 4, 2017, 8.35 PM), https://www.law360.com/articles/909920/millennium-to-brief-court-on-creditor-3rd-party-releases. Judge Silverstein was quoted to have said that “[a]ssuming I don’t decide to strike releases, then I think that there may be the necessity of proposed findings of fact and conclusions of law.” Id. at 3.

Stay tuned.

On March 23, 2017, the U.S. Bankruptcy Court for the Southern District of Florida (the “Court”) issued an opinion in the chapter 15 case of Banco Cruzeiro do Sul, S.A., a Brazilian bank (“BCSUL” or the “Debtor”), holding, among other things, that section 1521(a)(7) of the Bankruptcy Code does not prevent foreign representatives from commencing state law fraudulent conveyance actions.  See Laspro Consultores LTDA v. Alinia Corp. (In re Massa Falida Do Banco Cruzeiro Do Sul S.A.), No. 14-22974-BKC-LMI, Adv. Pro. No. 16-01315-LMI, 2017 WL 1102814 (Bankr. S.D. Fla. Mar. 23, 2017) (hereinafter, “Laspro”).  The opinion arose in the context of a motion to dismiss the complaint in an adversary proceeding commenced by Laspro Consultores LTDA, Trustee of BCSUL (“Plaintiff” or the “Foreign Representative”) against Alinia Corporation (“Alinia”) and 110 CPS, Inc. (“CPS” and together with Alinia, the “Defendants”).  See id., at *1.

The Foreign Proceeding and the Chapter 15 Case

In September 2012 BCSUL was placed into extra judicial liquidation by the Central Bank of Brazil.  Laspro, 2017 WL 1102814, at *1.  On June 14, 2014, BCSUL filed a petition in the Court for recognition of the Brazilian liquidation proceeding as a foreign main proceeding under sections 1515 and 1517 of the Bankruptcy Code.  See id., at *2.  On July 14, 2014, the Court entered an order recognizing the Brazilian liquidation proceeding as a “foreign main proceeding.”  Id.  On August 12, 2015, the Brazilian bankruptcy court decreed BCSUL bankrupt.  Id.  As of January 21, 2016, Plaintiff was the sole trustee of BCSUL’s estate.  Id.

The Adversary Complaint

On July 8, 2016, Plaintiff filed a complaint (as amended, the “Complaint”) in the Court based on allegations that Luis Felippe Indio da Costa (“Felippe”) and Luis Octavio Indio da Costa (“Octavio”), members of the family involved in BCSUL’s management, orchestrated a fraudulent loan scheme in which funds from BCSUCL were diverted to the Defendants.  Laspro, 2017 WL 1102814, at *2.  Felippe is alleged to be the settlor and sole beneficiary of the trust that owns Alinia.  Id.  CPS is owned by a Brazlian entity that is alleged to be jointly owned by Felippe and Octavio.  Id.  The Complaint alleges, among other things, that the diverted funds were used to purchase two apartments in New York City and certain artwork located therein, that allegedly were then transferred to the Defendants.  Id.  The counts in the Complaint fall into four basic categories: (i) imposition of a constructive trust/equitable lien; (ii) fraudulent conveyance under New York law; (iii) aiding and abetting; and (iv) four separate Brazlian law claims regarding consumer protection, misappropriation, unjust enrichment and fraudulent collusion.  Id., at *2*-3; see also Laspro, Docket No. 25.

The Motion to Dismiss

On October 26, 2016, Defendants filed a motion dismiss all counts of the Complaint arguing, among other things, that section 1521(a)(7) of the Bankruptcy Code precludes the Foreign Representative from bringing the state fraudulent conveyance counts because they were akin to “avoidance actions” under the Bankruptcy Code which the Foreign Representative did not have standing to prosecute.  Laspro, 2017 WL 1102814, at *3.  Section 1521(a)(7) of the Bankruptcy Code states that “[u]pon recognition of a foreign proceeding . . . the court may, at the request of the foreign representative, grant . . . any additional relief that may be available to a trustee, except for relief available under sections 522, 544, 545, 547, 548, 550, and 724(a)” of the Bankruptcy Code.  11 U.S.C. § 1521(a)(7).

The Court’s Holding

The Court relied on the explicit language of sections 1509 and 1521(a)(7) of the Bankruptcy Code to deny the motion to dismiss with respect to the state fraudulent conveyance claims.  Laspro, 2017 WL 1102814, at *6.  Specifically, although the Court acknowledged that section 1521(a)(7) does preclude a court from granting a foreign representative relief under “certain enumerated sections pursuant to which a bankruptcy trustee may bring avoidance actions,” it found that same section to “not prohibit a foreign representative from bringing avoidance claims that are available to the foreign representative generally under non-bankruptcy law.”  Id.  Moreover, the Court pointed to section 1509(f) of the Bankruptcy Code, which “makes clear” that “the failure of a foreign representative to commence a case or to obtain recognition under [chapter 15] does not affect any right the foreign representative may have to sue in a court in the United States to collect or recover a claim which is the property of the debtor.”  Id.; see also 11 U.S.C. § 1507(f).  Accordingly, the Court found that the Foreign Representative’s ability to seek relief under the New York state fraudulent conveyance laws stemmed not from its capacity as a “foreign representative” under chapter 15 of the Bankruptcy Code, but its capacity as the Brazilian bankruptcy judicial administrator “who represents the creditors of the estate under Brazilian law.”  Laspro, 2017 WL 1102814, at *6, *9; see also id., at *7 (“There is absolutely nothing in any part of chapter 15 that remotely suggests that a foreign representative may never bring an avoidance claim that the foreign representative has the direct right to bring in his or her capacity as the foreign representative (or as section 1509(f) makes clear — in his or her independent capacity otherwise).”).  For these same reasons, the Court also denied the motion to dismiss as to the constructive trust/equitable lien claims.  Id., at *9.

Conclusion

In light of the foregoing, it behooves foreign representatives to carefully analyze the nature of each cause of action they might be able to bring in a chapter 15 proceeding.

Traditional DIP Order Carve Outs Do Not Cap the Administrative Claims of Committee Professionals

On January 5, 2017, Judge Sontchi of the Bankruptcy Court for the District of Delaware issued an opinion (the “Opinion”) in the pending Molycorp Chapter 11 case (Case No. 15-11357).  In re Molycorp, Inc., 562 B.R. 67 (Bankr. D. Del. 2017).  In the Opinion, the Court rejected a challenge by OCM MLYCo. Ltd. (“Oaktree”), one of Molycorp’s pre-petition secured lenders, Molycorp’s DIP Lender and, in combination with Molycorp’s other set of secured lenders, purchaser of Molycorp’s more profitable operating subsidiaries, to the fees & expenses of Paul Hastings LLP, lead counsel to the Official Committee of Unsecured Creditors (the “Committee”).

Background

Molycorp’s Chapter 11 has been extremely contentious and detailing its history would take many pages.  The facts relevant to the Opinion are quite simple.  The DIP Financing Order entered by the Court provided for a carve-out of $250,000 for the Committee to investigate pre-petition claims against Oaktree (the “Investigation Budget”).  D.I. 278, ¶ 4(b).  The Committee began investigating potential claims against Oaktree almost immediately and, on January 14, 2016, the Court entered an order granting the Committee standing to bring litigation on the estate’s behalf against Oaktree.  D.I. 1086.  After mediation with all major parties in the case before the Honorable Robert D. Drain (SDNY), the Debtors filed a notice of the execution of a global settlement agreement on February 22, 2016, including a settlement of the claims brought by the Committee (the “Settlement Agreement”).  D.I. 1302, Settlement Agreement at Ex. A.  In the Court’s own words, “[t]he Settlement Agreement paved the way for a consensual reorganization plan for certain of the Debtors.”  Molycorp, 562 B.R. at 72.  On April 8, 2016, the Court entered an Order confirming a plan of reorganization premised on the Settlement Agreement.  D.I. 1580.

After the Settlement Agreement was approved, Paul Hastings filed a Second Interim Fee Application, covering the period from September 1, 2015 to March 31, 2016, requesting Court approval of $8,491,064.75 in fees and $226,179.06 in expenses (the “Fee Application”).  Oaktree objected to Paul Hastings’ Fee Application on four grounds.  First, Oaktree argued that the DIP Financing Order established a dispositive cap of $250,000.00 (the “Cap”) on the fees and expenses of the Committee counsel in relation to the investigation of claims against Oaktree.  Id. at 73.  Second, Oaktree argued that the DIP Financing Order only authorized the compensation of the Committee’s professionals for the investigation of claims, not for the initiation and prosecution of such claims.  Id.  Third, Oaktree argued that even if the Cap was not dispositive, “any portion of Paul Hastings’ fees that exceeds the cap set by the DIP Financing Order is presumptively unreasonable.”  Id. at 73-74.  Finally, Oaktree argued that the descriptions of the work performed by Paul Hastings’ attorneys were excessively vague and should be disallowed.  Id. at 74.

The Opinion

The Court’s opinion was decisive but comprehensive.  As the Court explained, before confirmation of a plan, “absent equity in the [secured party’s] collateral, administrative claimants cannot look to encumbered property to provide a source of payment for their claims.”  Molycorp, 562 B.R. at 75.  Thus, there was no doubt that as the secured party, Oaktree’s consent was necessary for the payment of administrative expenses and Oaktree was within its rights to “impose[] a limit on the amount of its collateral which may be used to pay the attorneys employed by the Committee.”  Id. at 77.

11 U.S.C. § 1129(a)(9)(A), however, mandates that for a plan to be confirmed, each holder of an allowed administrative expense claim, unless agreed otherwise, must be paid in cash equal to the allowed amount of such claim on the effective date of the plan.  Molycorp, 562 B.R. at 77.  Therefore, “if the secured parties desire confirmation, the administration claims must be paid in full in cash even if it means invading their collateral.”  Id. at 78 (quoting In re Emons Industries, Inc., 76 B.R. 59, 60 (Bankr. S.D.N.Y. 1987)).  Therefore, “in the context of a plan confirmation, a cap on the amount to be paid towards administrative expenses may only be approved after obtaining the administrative claimants’ consent.”  Molycorp, 562 B.R. at 78.

The Court then held that the Investigation Budget in the DIP Order unambiguously “[did] not contain any language that can compel automatic disallowance of Paul Hastings’ fees.”  Id. at 79.  The Court saw nothing in the language of the DIP Order that differed from a standard carve-out provision.  Id.  The Court  also noted the difference between the language in the DIP Order and the language in the Confirmed Plan, which stated that “[a]ny amounts incurred by the Creditors’ Committee’s legal professionals on and after the Committee Settlement Effective Date with respect to the Creditors’ Committee Legal Fee Cap Matters in excess of the Creditors’ Committee Legal Fee Cap shall be disallowed.”  Id. at 80 (emphasis in original).  The Court noted that the difference in language spoke for itself and made absolutely clear that “the costs incurred by Paul Hastings are not affected by the DIP Financing Order.”  Id.  Finally, the Court concluded by allowing Paul Hastings’ fees and expenses as reasonable compensation for services rendered, noting that the “record demonstrates that the services rendered benefited the Debtor’s estate and advantaged the Committee’s constituents.”  Id. at 82.

The Unanswered Question—Can a DIP Order Ever Be Used to Cap The Committee’s Professionals’ Administrative Claims?

The Court declined to answer whether it would ever uphold a provision in a DIP Order capping the allowable administrative claims of the Committee’s professionals.  Id. at p. 80, n. 62.  Both the parties and the Court noted that other courts had approved such provisions in a DIP Order, most notably In re Granite Broadcasting Corp. (ALG) (Bankr. S.D.N.Y. Jan. 5, 2007).  The Court did, however, note that there was an ongoing debate “with regard to the term ‘agreed’ [in § 1129(a)(9)(A)]: whether this requires a creditor expressly or affirmatively consent to a different treatment, or whether consent may be implied from the creditor’s conduct.”  Molycorp, 562 B.R. at 78, n. 54.

The Court’s acknowledgement of this debate was not mere happenstance.  If consent to lesser treatment may be implied from a creditor’s conduct, a court could find that by accepting employment from the Committee after such a DIP Order has been entered, a Committee professional has impliedly consented to the hard cap in the DIP Order.  If, however, implied consent is insufficient, it seems unlikely that a Court could ever find a hard cap in a DIP Order binding.

The Court did, however, signal its position on this debate in a footnote.  In explaining the debate over the type of consent necessary under § 1129(a)(9)(A), the Court cited to In re Teligent, Inc., in which administrative creditors who had not returned a ballot were deemed to have agreed to lesser treatment (the case was administratively insolvent).  The Court viewed the holding in Telligent as a “questionable fiction.”  Molycorp, 562 B.R. at 78, n. 54.  It therefore appears questionable that Judge Sontchi will be well disposed to arguments that an administrative claimant has impliedly consented to lesser treatment and, by implication, to DIP Orders which attempt to place a hard cap on the administrative claims of Committee professionals.

Sometimes the smallest bankruptcy cases give rise to the most interesting legal questions.  One such case was that of ScripsAmerica, Inc., which gave rise to the question of whether the Office of the United States Trustee (the “UST”) has the statutory authority to disband a committee of unsecured creditors once a committee is appointed, or whether that authority resides with the Bankruptcy Court.

By way of background, ScripsAmerica was a publicly-traded holding company whose primary assets were its ownership interest in a compounding pharmacy known as Main Avenue Pharmacy, Inc., 90% interest in a pharmaceutical wholesaler, and indirect control over another compounding pharmacy.  Substantially all of ScripsAmerica’s revenues, however, were derived from Main Avenue.  Main Avenue was forced to shut down its operations, depriving ScripsAmerica of any meaningful source of revenue.  ScripsAmerica had its own problems as well, including protracted litigation with an entity known as Ironridge Global IV, Ltd., which had paid off certain debts in return for the issuance of shares of ScripsAmerica and the resignation of the CEO and President of the company under a cloud of suspicion.

ScripsAmerica filed for bankruptcy protection on September 7, 2016.  See In re ScripsAmerica, Inc., Case No. 16-11991 (LSS).  On November 3, 2016 the UST appointed a committee (the “Committee”) consisting of two members: the former CEO and Ironridge.  Almost immediately, on November 4, 2016, the debtor filed a motion to disband the Committee, to which both the UST and Committee objected on November 21, 2016.

In its motion to disband the Committee, the debtor relied heavily on the fact that there were only two members of the Committee, one of which was a party against whom the debtor had been engaged in protracted pre-petition litigation and the other being the former CEO (an insider) of the debtor against whom the debtor alleged it had various claims (including, inter alia, claims related to the CEO entering into the Ironridge agreement in the first instance).   The debtor took the position that the Bankruptcy Court had the authority to disband the Committee pursuant to sections 105(a) and 105(d) of the Bankruptcy Code and relied upon case law in which a bankruptcy court had done so, albeit after appointment of a chapter 11 trustee.  See In re Pacific Ave., LLC, 467 B.R. 868, 870 (Bankr. W.D.N.C. 2012).

In their objections, the UST and Committee argued, among other things, that the Bankruptcy Court lacked statutory authority to disband a committee (except where a chapter 11 case is a small business case) because section 1102 is silent on the authority of a Bankruptcy Court to do so and section 105(d) cannot be deployed to expand the Bankruptcy Court’s authority beyond what it is statutorily granted.

The issue of disbandment languished for a time but revved up again when the debtor and Committee could not reach agreement on a plan of reorganization, at which point the debtor re-noticed its motion.  On January 11, 2017, the UST filed a notice of disbandment of the Committee.  The Court directed the Committee to file an adversary proceeding in order to resolve the question of whether the UST had statutory authority to disband the Committee.

In its brief notice of disbandment, the UST asserted that it had the statutory authority to disband the committee under 28 U.S.C. § 586(a)(3)(E), which authorizes the UST to “supervise the administration of cases … under chapter … 11 … of title 11 by, whenever the United States trustee considers it to be appropriate – monitoring creditors’ committees appointed under title 11.”

In its motion for summary judgment, the committee argued in the first instance that the UST’s purported disbandment of the committee violated the careful separation between administrative powers (vested in the UST) and judicial powers (vested with the Bankruptcy Court) inherent in the Bankruptcy Code.  The crux of the Committee’s argument, however, was that the UST simply has no statutory authority to disband a committee.

The committee first looked to section 1102 of the Bankruptcy Code, pursuant to which the UST is directed to appoint a committee and given authority to appoint additional members to a committee.  Nothing in that provision, however, expressly authorizes the UST to disband a committee.  See 11 U.S.C. § 1102.  The committee invoked the doctrine of expression unius est exclusion alterius, noting that Congress’s failure to include within section 1102(a)(1) the power to disband a committee once appointed precluded the UST from doing so.  On the other hand, the committee pointed out that section 1102(a)(4), added by BAPCPA, provides that the Court may order the UST to change the composition of the committee.   With regard to 28 U.S.C. §  586(a)(3)(E), the committee pointed out that the term “monitoring” was consistent with the administrative functions delegated to the UST, but did not encompass the judicial function of disbanding the committee.

The debtors—who had originally argued that the Bankruptcy Court had the authority to disband the committee in their motion requesting that it do so—argued in their opposition that the power to disband a committee is “inherent” in the UST’s authority under section 1102(a)(1) to form a committee, in conjunction with the UST’s power to “monitor” the committee under 28 U.S.C. § 586(a)(3)(E).  The debtors claimed that, prior to BAPCPA and the addition of section 1102(a)(4), the UST’s ability to remove committee members was not subject to Court review, although the debtor never actually pointed to any basis upon which that unfettered authority existed.  The debtors then relied heavily upon the case of In re VentureLink Holdings, Inc., 299 B.R. 420 (Bankr. N.D. Tex. 2003).  While VentureLink did contain similar facts to those in ScripsAmerica, the opinion largely proved the Committee’s point: the composition of the committee in VentureLink was modified, not by an edict of the UST (which had refused to remove the member in question), but by an order of the Bankruptcy Court.  See 299 B.R. at 424.  The VentureLink decision suggests that the UST has the authority to remove members of a committee in the first instance, but final authority rests with the Bankruptcy Court.

The UST never submitted a brief in support of its notice of disbandment because, before it was required to do so, ScripsAmerica’s chapter 11 proceeding was converted to a chapter 7, largely because the estate was administratively insolvent, in no small part because of the litigation over disbandment of the Committee.

Predicting where the Bankruptcy Court might have come out on the issue is impossible because, in the end, neither the Bankruptcy Code nor title 28 clearly grant anybody—either the Court or the UST—the authority to disband a committee.  Logic would seem to dictate that some mechanism for eliminating a committee under the right circumstances should exist, but Congress does not appear to have given statutory expression to that logical observation.

Nor does the case law provide clear guidance.  In a relatively recent decision, a Bankruptcy Court concluded that it lacked statutory authority to disband a committee once appointed, but did not find that the UST had the authority to disband a committee.  See, e.g., In re Caesars Entm’t Operating Co, Inc., 526 B.R. 265 (Bankr N.D. Ill. 2015) (in fact, the UST shared the moving debtors’ concern that the committee in question would engage in duplicative activities that would increase fees, yet the court did not suggest the UST had the power to disband the committee); cf. Credit Suisse AG v. Appaloosa Inv. L.P., 2015 WL 52570003 at *5 (S.D.N.Y. Sep. 9, 2015) (discussing court’s earlier order denying motion to disband on grounds that court lacked statutory authority).  In another case, the Bankruptcy Court declined to rule on whether it had the authority to disband a committee because it concluded on the facts that doing so was not appropriate, though the court also did not conclude that only the UST had the authority to disband a committee.  See In re Dewey & Leboeuf LLP, 2012 WL 5985325 (Bankr. S.D.N.Y. Nov. 29, 2012).  However, counsel seeking to have a committee disbanded may take heart in the fact that in at least one case a court allowed the fees of the movant.  See In re Keene Corp., 205 B.R. 690, 704-05 (Bankr. S.D.N.Y. 1997).

Unfortunately for those seeking clarity on the scope of the UST’s authority, the conversion of the ScripsAmerica case mooted the issue of the disbandment of the committee.  Thus, the bankruptcy bar will have to wait until the next time the UST seeks to disband a committee for case law on whether the UST has that authority.

Disclosure:  Cole Schotz P.C. represents a significant unsecured creditor of ScripsAmerica, Inc. and advocated for the conversion of the case to a chapter 7 proceeding.  Neither Cole Schotz P.C. nor its client took any position on the authority of the UST to disband the Committee.

Since February 2016, the Local Rules for the United States Bankruptcy Court for the District of Delaware provide for combined hearings on approval of disclosure statements and confirmation of plans and for the use of combined disclosure statement and plans in liquidating chapter 11 cases.

Although combined hearings in such cases occurred prior to the enactment of the new rule, they were relatively rare and often subject to objection.  Such objections were largely based upon the limitations in section 1125(f) of the Bankruptcy Code that provides, among other things, that “the court may determine that the plan itself provides adequate information and that a separate disclosure statement is not necessary” and that “the hearing on the disclosure statement may be combined with the hearing on confirmation of a plan” in a small business case.  The Code is silent on the process as it relates to non-small business chapter 11 cases.

For example, in In re Corinthian Colleges, Inc., No. 15-10952 (KJC), the Department of Education objected to a combined process arguing that “[a]n integrated plan and disclosure statement is permitted for small business bankruptcies . . . [and] [b]y authorizing a combined disclosure statement and plan for chapter 11 bankruptcies of small businesses, Congress implicitly prohibited them for other chapter 11 bankruptcies.”  [D.I. 580].  Similarly in In re Old FOH, Inc., No. 15-10836 (KG), the debtors submitted a combined plan and disclosure statement.  In that case, the United States Trustee objected arguing, among other things, that a combined document is ordinarily only appropriate in small business cases.  [D.I. 421].  In each case, the court overruled the objections.

Other Judges in the District of Delaware have approved combined hearings on the approval of disclosure statements and the confirmation of chapter 11 plans in non-small business and non-prepacked cases prior to the enactment of the rule.  See, e.g., In re Hipcricket, Inc., Case No. 15-10104 (LSS) (Bankr. D. Del. Mar. 31, 2015); In re AFA Investment Inc., Case No. 12-11127 (MFW) (Bankr. D. Del. January 16, 2014); In re Devonshire PGA Holdings, LLC, Case No. 13-12460 (CSS) (Bankr. D. Del. Oct. 16, 2013); In re Rubicon US REIT, Inc., Case No. 10-10160 (BLS) (Bankr. D. Del. June 21, 2010).

Now a combined process, including the use of a combined document containing the plan and disclosure statement, is expressly contemplated by Local Rule 3017-2 which provides as follows:

(a)   Applicability. This Local Rule shall be applicable to all cases arising under chapter 11 of the Code where the following requirements are met:

(i)  All or substantially all of the assets of the debtor[s] were or will be liquidated pursuant to a sale under 11 S.C. § 363; and

(ii)  The plan of liquidation proposes to comply with section 1129(a)(9) of the Code; and

(iii)  The plan of liquidation does not seek non-consensual releases/injunctions with respect to claims creditors may hold against non-debtor parties; and

(iv)  The debtor’s combined assets to be distributed pursuant to the proposed plan of liquidation are estimated, in good faith, to be worth less than $25 million (excluding causes of action).

(b)  Combined Disclosure Statement and Plan of Liquidation. A plan proponent may combine the disclosure statement and plan of liquidation into one document.

Since the enactment of Local Rule 3017-2, the use of combined plan and disclosure statements and/or combined hearings appear to have increased, particularly in liquidating cases with assets less than $25 million.  See, e.g., In re SDI Solutions LLC, Case No. 16-10627 (CSS) (Bankr. D. Del. May 24, 2016); DNIB Unwind, Inc. (f/k/a BIND Therapeutics, Inc., et al., Case No. 16-11084 (BLS) (Bankr. D. Del. Sept. 26, 2016).

Proponents of the combined process contend that it is more streamlined, less expensive, and quicker.  See, e.g., In re JMO Wind Down, Inc., Case No. 16-10682 (BLS) [D.I. 320].  The author predicts that practioners in the District of Delaware will continue to increasingly take advantage of the combined process in the right cases due to the enactment of Local Rule 3017-2.