Last November, we reported on the long-standing circuit split between the First and Seventh Circuits regarding the effect of rejection of a trademark license agreement under section 365 of the Bankruptcy Code.

This morning, in Mission Product Holdings, Inc. v. Tempnology, LLC,  2019 WL 2166392, the Supreme Court affirmed the Seventh Circuit’s reasoning and held 8-1 that a debtor-licensor’s rejection of a non-exclusive trademark license agreement under section 365 of the Bankruptcy Code does not prohibit its licensee from continuing to use that trademark.  In so doing, the Court flatly rejected arguments that rejection functions as a quasi-rescission:

Today, we hold that both Section 365’s text and fundamental principles of bankruptcy law command the first, rejection as- breach approach. We reject the competing claim that by specifically enabling the counterparties in some contracts to retain rights after rejection, Congress showed that it wanted the counterparties in all other contracts to lose their rights. And we reject an argument for the rescission approach turning on the distinctive features of trademark licenses. Rejection of a contract—any contract—in bankruptcy operates not as a rescission but as a breach.

Id. at *5.

But while the Court provided helpful guidance on the legal effect of a rejection under section 365, Justice Sotomayor emphasized in her concurrence that the “baseline inquiry remains whether the licensee’s rights would survive a breach under applicable nonbankruptcy law.”  Id. at *9.  Thus, according to Justice Sotomayor, it is conceivable that “special terms” in a licensing agreement or provisions of state law could affect a licensee’s right in an individual case.  Id.

There is little question that debtors (and their licensing counterparties) will test the bounds of those “special terms” in the coming years.  But, at least for now, section 365 “does not grant the debtor an exemption from all the burdens that generally applicable law—whether involving contracts or trademarks—imposes on property owners.”  Id. at *8.

Upcoming Committee Formation Meeting: Wednesday, May 22, 2019

Case Name: 19-11047 (KG)

Location: The Du Pont Hotel 42 W. 11th Street Wilmington, DE 19801

Notice of Formation Meeting for Official Committee of Unsecured Creditors can be found here. See the petition for relief.

Contact Norman L. Pernick, G. David Dean or Myles R. MacDonald for more information regarding this matter.

Upcoming Committee Formation Meeting: Tuesday, May 21, 2019

Case Name: 19-11095 (CSS)

Location: Office of the US Trustee 844 King Street, Room 3209 Wilmington, DE 19801

Notice of Formation Meeting for Official Committee of Unsecured Creditors can be found here. See the petition for relief.

Contact Norman L. Pernick, G. David Dean or Myles R. MacDonald for more information regarding this matter.

EdgeMarc Energy Holdings, LLC, along with eight affiliates and subsidiaries, has filed a petition for relief under chapter 11 in the Bankruptcy Court for the District of Delaware (Lead Case No. 19-11104).  EdgeMarc, headquartered in Canonsburg, PA, is a natural gas exploration and production company with 60 producing wells in the Appalachian Basin.  The First Day Declaration explains that an explosion along a pipeline system gathering gas from a number of EdgeMarc’s wells, as well as the litigation that explosion spawned, has led to a third of EdgeMarc’s production capacity laying idle.  A press release issued by EdgeMarc explains that EdgeMarc intends to sell substantially all of its assets under section 363 of the Bankruptcy Code.  Prime Clerk is the proposed claims and noticing agent.  The cases have been assigned to the Honorable Brendan Linehan Shannon.

Contact Norman L. Pernick, G. David Dean or Myles R. MacDonald for more information regarding this matter.

JRV Group USA L.P., an Ontario, CA-based tier 2 original equipment manufacturer for Jeep Wranglers, has filed a petition for relief under chapter 11 in the Bankruptcy Court for the District of Delaware (Case No. 19-11095).  The First Day Declaration explains that JRV was formerly the US operating subsidiary of Erwin Hymer Group, a Germany-based recreational vehicle company, and intends to wind down its operations through the chapter 11 case.   BMC Group is the proposed claims and noticing agent.  The case has been assigned to the Honorable Chief Judge Christopher S. Sontchi.

Contact Norman L. Pernick, G. David Dean or Myles R. MacDonald for more information regarding this matter.

On April 24, 2019, the U.S. Court of Appeals for the First Circuit (the “First Circuit”) issued an opinion in the case of Popular Auto, Inc. v. Reyes-Colon (In re Reyes-Colon), Nos. 17-1971-72, 2019 WL 1785039 (1st Cir. Apr. 24, 2019), holding that bankruptcy courts cannot utilize their equitable powers to override the explicit requirement in section 303(b)(1) of the Bankruptcy Code that three or more petitioning creditors are required to commence an involuntary bankruptcy proceeding where the alleged debtor has twelve or more creditors.  Id., at *7; see also 11 U.S.C. § 303(b)(1).  Relying on the U.S. Supreme Court case of Law v. Siegel, 571 U.S. 415 (2014), the First Circuit rejected the petitioning creditors’ attempt to invoke the judicially created “special circumstances” exception, which excuses section 303(b)(1)’s numerosity requirement where the alleged debtor is found to have engaged in fraudulent conduct.  Reyes-Colon, 2019 WL 1785039, at *6-*7.

Statutory and Legal Background

Under section 303(b) of the Bankruptcy Code, fewer than three petitioning creditors cannot force an alleged debtor into bankruptcy unless the alleged debtor has fewer than twelve eligible creditors.  See 11 U.S.C. § 303(b); see also Reyes-Colon, 2019 WL 1785039, at *2.

Notwithstanding the explicit language of section 303(b)(1), however, several courts have endorsed a “special circumstances” exception to the three petitioning creditor requirement where the alleged debtor has engaged in “trick, artifice, scam, or fraud.”  In re Norriss Bros. Lumber Co., Inc., 133 B.R. 599, 609 (Bankr. N.D. Tex. 1991); see also In re CorrLine Int’l, LLC., 516 B.R. 106, 161 (Bankr. S.D. Tex. 2014) (“Considering that this Court has already found reason to question Hatle’s credibility . . . and considering the evidence of invoice manipulation, this Court finds that a ‘special circumstances’ exception to the three-creditor requirement is warranted in this case.”).

Other courts have declined to contravene the specific statutory requirement and refused to allow petitioning creditors to utilize the exception.  See, e.g., Azur-US, Inc. v. DBH Ltd., Inc., 234 F.3d 1267 (6th Cir. 2000) (“We find no basis in the statute for concluding that a fraud-related exception exists to the § 303(b) requirements.”); In re Green, Nos. 06-11761-FM, 06-11762-FM, 2007 WL 1093791, at *7 (Bankr. W.D. Tex. 2007) (“The Court condones neither the Debtors’ past fraudulent behavior nor their current behavior. However, this Court must abide by the statutory construction of § 303(b). The statute is clear on its face and contains no fraud exception.”).

Procedural History

On November 22, 2006, Banco Popular de Puerto Rico (“Banco Popular”) filed an involuntary bankruptcy petition against Edgar Reyes-Colon (the “Alleged Debtor”), a plastic surgeon, in the U.S. Bankruptcy Court for the District of Puerto Rico (the “Bankruptcy Court”).  Reyes-Colon, 2019 WL 1785039, at *1.  The petition later was joined by a second creditor, Popular Auto, Inc. (together with Banco Popular, the “Banks”).  Id.  In early 2007, the Bankruptcy Court dismissed the involuntary petition on the basis that the Alleged Debtor had more than twelve eligible creditors and the numerosity requirement of section 303(b)(1) had not been met because there were only two petitioning creditors.  Id.  A year and a half later, the Bankruptcy Appellate Panel for the First Circuit set aside the dismissal and remanded on the basis that all creditors should have been given the opportunity for a hearing before the Bankruptcy Court dismissed the case.  Id.

 After several additional years of litigation, in May of 2012 the Bankruptcy Court granted in part a subsequent motion to dismiss by the Alleged Debtor on the basis that he had more than twelve qualified creditors at the time the involuntary petition was filed.  Reyes-Colon, 2019 WL 1785039, at *1.  However, the Bankruptcy Court permitted the parties to conduct discovery and present evidence on, among other things, whether “special circumstances” existed to excuse compliance with section 303(b)(1)’s three-creditor requirement.  Id.  On September 2, 2016, the Bankruptcy Court dismissed the involuntary petition, finding that although the Alleged Debtor had engaged in a scheme to defraud his creditors by misrepresenting his finances, the court “did not have the equitable power to override the provisions of section 303(b)(1).”  Id.; see also id., at *7 (describing the Banks’ assertions that the Debtor had “conducted himself fraudulently to avoid paying his debts” and that he had “claim[ed] more creditors than ha[d]”).

The Banks appealed to the U.S. District Court for the District of Puerto Rico, which reversed the Bankruptcy Court’s dismissal on the basis that, among other things, the three petitioning creditor requirement did not need to be met because the Alleged Debtor had fewer than twelve eligible creditors when the petition was filed.  Reyes-Colon, 2019 WL 1785039, at *2.  The Alleged Debtor appealed that ruling and the Banks cross-appealed.  Id.

The Court’s Decision

The Banks’ central arguments on appeal before the First Circuit relating to section 303(b) were that the Bankruptcy Court erred by failing to: (i) place the burden on the Alleged Debtor to prove that he had twelve or more eligible creditors; (ii) find that the Banks had presented evidence sufficient to show that the Alleged Debtor did not have twelve or more eligible creditors; and (iii) employ equitable discretion to allow the petition.  Reyes-Colon, 2019 WL 1785039, at *4.

With respect to the Banks’ first argument, the First Circuit explained that the once an alleged debtor answers the petition by stating that there are more than twelve creditors and files a list of creditors in compliance with Bankruptcy Rule 1003(b), the petitioning creditors bear the burden to rebut the alleged debtor’s proof.  Reyes-Colon, 2019 WL 1785039, at *4-*5 (“[T]he bankruptcy court properly placed the burden of proving creditor eligibility on the Banks.”).

With respect to the Banks’ second argument, the First Circuit observed that even if the District Court had erred in finding certain disputed creditors to be eligible, the Alleged Debtor still had twelve creditors at the time the involuntary petition was filed, which required there to be at least three petitioning creditors in accordance with section 303(b)(1).  Reyes-Colon, 2019 WL 1785039, at *6.

Finally, the First Circuit noted that although bankruptcy courts do have the authority to provide equitable relief, they do not have the ability to “‘contravene specific statutory provisions’ when they exercise their statutory and inherent powers.”  Reyes-Colon, 2019 WL 1785039, at *6 (citing Siegel, 571 U.S. at 421).  Indeed, the court noted that “the bankruptcy court would have plainly contravened section 303(b) if it bypassed the involuntary petition’s creditor numerosity deficiency via the ‘special circumstances’ doctrine,” and allowing the case to proceed would have “flown in the face of the Code’s directive.”  Id.  Therefore, the court held that “Siegel forecloses employing equity to waive this plain statutory requirement.”  Id.

Conclusion

Although the First Circuit has foreclosed use of the “special circumstances” exception in involuntary bankruptcy cases where there are less than three petitioning creditors, the judicially created concept is alive and well in other jurisdictions.  See, e.g., Norriss Bros., 133 B.R. at 608-09; H.I.J.R. Props. Denver v. Schideler (In re H.I.J.R. Props. Denver), 115 B.R. 275, 278 (D. Colo. 2012).  Accordingly, to the extent one or two creditors are considering filing an involuntary petition against an alleged debtor with more than twelve creditors, they should be mindful of how courts in their proposed filing jurisdiction treat the exception.

Cloud Peak Energy Inc. (OTCMKTS: CLDP), along with twenty-eight subsidiaries and affiliates, has filed a petition for relief under chapter 11 in the Bankruptcy Court for the District of Delaware (Lead Case No. 19-11047).  Cloud Peak, headquartered in Gillette, WY, owns and operates three coal mines in the Powder River Basin.  According to a press release from the Debtors, Cloud Peak enters chapter 11 having entered into a plan support agreement (attached to the First Day Declaration as Exhibit C) with holders of approximately 62% in dollar amount of the Company’s secured notes due 2021 and more than 50% in dollar amount of the Company’s unsecured notes due 2024.  The First Day Declaration explains that the plan support agreement contemplates a sale of substantially all of the Debtors’ assets under section 363 of the Bankruptcy Code.  Prime Clerk is the proposed claims and noticing agent.  The cases have been assigned to the Honorable Kevin Gross.

Contact Norman L. Pernick, G. David Dean or Myles R. MacDonald for more information regarding this matter.

Upcoming Committee Formation Meeting: Friday, May 17, 2019

Case Name: 19-10990 (BLS)

Location: The Doubletree Hotel 700 King Street Wilmington, DE 19801

Notice of Formation Meeting for Official Committee of Unsecured Creditors can be found here. See the petition for relief.

Contact Norman L. Pernick, G. David Dean or Myles R. MacDonald for more information regarding this matter.

Upcoming Committee Formation Meeting: Friday, May 17, 2019

Case Name: 19-10990 (BLS)

Location: Office of the US Trustee 844 King Street, Room 3209, Wilmington DE 19801

Notice of Formation Meeting for Official Committee of Unsecured Creditors can be found here. See the petition for relief.

Contact Norman L. Pernick, G. David Dean or Myles R. MacDonald for more information regarding this matter.

Triangle Petroleum Corporation (OTCMKTS: TPLM), along with three subsidiaries and affiliates, has filed a petition for relief under chapter 11 in the Bankruptcy Court for the District of Delaware (Lead Case No. 19-11025).  Triangle, headquartered in Denver, CO, is the former parent company of Triangle USA Petroleum Corp., which filed for chapter 11 (Lead Case No. 16-11566) in June 2016 and emerged from bankruptcy in March 2017.  According to Triangle’s First Day Declaration, Triangle is an independent energy holding company that operates through a number of non-Debtor subsidiaries.  The First Day Declaration further explains that Triangle has filed and solicited votes on a prepackaged plan of reorganization, which is supported by J.P. Morgan Securities, LLC, Triangle’s secured creditor and the only party allegedly entitled to vote on the prepackaged plan.  General unsecured creditors and other secured claims are unimpaired under the prepackaged plan.  The Disclosure Statement can be found here.  Triangle is seeking to have the Court hold a combined confirmation and disclosure statement approval hearing on June 14, 2019Epiq is the proposed claims and noticing agent.  The cases have been assigned to the Honorable Mary F. Walrath.

Contact Norman L. Pernick, G. David Dean or Myles R. MacDonald for more information regarding this matter.