United States: Notable Business Bankruptcy Decisions Of 2012

ALLOWANCE/DISALLOWANCE/PRIORITY/DISCHARGE OF CLAIMS

"Key employee" retention plans proposed by bankrupt companies have been subject to rigorous scrutiny since Congress amended the Bankruptcy Code in 2005 to add section 503(c), which makes it much more difficult to implement such programs. Several notable court rulings were handed down in 2012 concerning the propriety under section 503(c) of payments to key employees. Many of these decisions concern the increasing frequency with which chapter 11 debtors have characterized proposed payments to personnel as a key employee incentive program ("KEIP"), which is generally governed by the less stringent requirements of section 503(c)(3), rather than as a key employee retention plan ("KERP"), which is strictly regulated by section 503(c)(1).

During 2012, several courts adopted the "business judgment" standard applied to a proposed nonordinary-course use, sale, or lease of estate property pursuant to section 363(b) of the Bankruptcy Code as a litmus test for payments governed by section 503(c)(3). See, e.g., In re Dewey & LeBoeuf LLP, 2012 WL 3065275 (Bankr. S.D.N.Y. July 30, 2012); In re Global Aviation Holdings Inc., 478 B.R. 142 (Bankr. E.D.N.Y. 2012); In re Velo Holdings Inc., 472 B.R. 201 (Bankr. S.D.N.Y. 2012).

In Velo Holdings, the court concluded that the chapter 11 debtors' proposed KEIP established incentive targets that, although tied to the debtors' compliance with a debtor-in-possession budget, required key employees to "stretch" in order to qualify for plan payments, so as not to constitute a retention plan subject to the restrictions set forth in sections 503(c)(1) and (2). The court ruled that the debtors met their burden of proving that the proposed KEIP was primarily incentive-based as it related to key employees and that implementation of the plan was a valid exercise of sound business judgment under sections 363 and 503(c)(3).

In In re Hawker Beechcraft, Inc., 479 B.R. 308 (Bankr. S.D.N.Y. 2012), the court denied the debtor's motion to implement a KEIP that would have paid bonuses of up to $5.3 million to a "senior leadership team" and concluded that, although the KEIP included elements of incentive compensation, "when viewed as a whole, it set[] the minimum bonus bar too low to qualify as anything other than a retention program for insiders."

In In re Residential Capital, LLC, 478 B.R. 154 (Bankr. S.D.N.Y. 2012), the court denied the debtors' bid to pay more than $7 million in bonuses to 17 top executives and ruled that the plan had been improperly structured to ensure that top management would not leave the company rather than to incentivize them to meet performance goals. "Ultimately, the Debtors have failed to carry their burden," the court wrote, pointing to a provision that 63 percent of the bonus money could be earned simply by the debtors' closing the sales of two loan portfolios that had been substantially negotiated prepetition. However, the court later approved the payments after the debtors made changes to the KEIP designed to make it more incentivizing.

In In re Blitz U.S.A., Inc., 475 B.R. 209 (Bankr. D. Del. 2012), the court concluded that a bonus plan proposed by the debtor was an ordinary-course transaction, and therefore not subject to section 503(c), because the debtor had implemented similar plans for the three years preceding its chapter 11 filing and because other manufacturers had employed similar plans.

In keeping with courts' narrow construction of what constitutes "substantial contribution" in a chapter 11 case within the meaning of section 503(b)(3)(D) of the Bankruptcy Code, the bankruptcy court in In re AmFin Financial Corp., 468 B.R. 827 (Bankr. N.D. Ohio 2012), denied administrative-expense priority to the fees and expenses of senior noteholders, noting, among other things, that "the efforts by the Senior Noteholders to settle their own claims [were] not properly characterized as a substantial contribution to the case."

In Machne Menachem, Inc. v. Spritzer (In re Machne Menachem), 2012 WL 8570 (3d Cir. Jan. 3, 2012), the Third Circuit, addressing the power of a court to recharacterize debt as equity, affirmed a bankruptcy court's ruling that certain advances made by a purported lender to a not-for-profit debtor were not loans. The bankruptcy court had looked to the intent of the parties as it existed at the time of the transaction; analyzed the parties' intent in keeping with the Third Circuit's earlier ruling in Cohen v. K.B. Mezzanine Fund II (In re SubMicron Sys. Corp.), 432 F.3d 448 (3d Cir. 2006); and held that the advances were donations. The Third Circuit ruled that the bankruptcy court's determination was not clearly erroneous because: (i) "there [was] no written instrument for the court to analyze and determine whether the terms suggest[ed] an expectation of repayment," even though some of the checks had "loan" written on them; and (ii) there was "no evidence of intent on behalf of [the debtor] to accept or authorize the purported loans, such as a resolution from the board of directors, or evidence that the board was aware of the loans."

In Wright v. Owens Corning, 679 F.3d 101 (3d Cir. 2012), the Third Circuit held that, although it had previously reversed the rule stated in Avellino & Bienes v. M. Frenville Co. (In re M. Frenville Co.), 744 F.2d 332 (3d Cir. 1984), governing when a "claim" arises for purposes of discharge in bankruptcy, due-process considerations mandated that the claims of certain unknown defective-product claimants not be discharged - thereby resuscitating Frenville's results in certain circumstances and adding another layer of complexity to the analysis of discharged claims.

In In re Heritage Highgate, Inc., 679 F.3d 132 (3d Cir. 2012), the Third Circuit ruled that, in a chapter 11 reorganization, the term "value," as applied to section 506(a), should mean the fair market value of collateral as of plan confirmation. In so ruling, the court of appeals rejected the market-based, or "wait and see," approach recommended by a group of secured creditors, whose subordinated claims would be rendered unsecured unless the court included projected revenues from the debtor's chapter 11 plan in the valuation analysis. Applying the fair-market-value approach to calculate the amount of a creditor's secured claim, the Third Circuit held, does not constitute impermissible lien stripping. In addition, the court adopted a burden-shifting approach to the question of who bears the burden of demonstrating value.

In Statek Corp. v. Dev. Specialists, Inc. (In re Coudert Bros. LLP), 673 F.3d 180 (2d Cir. 2012), the Second Circuit considered as a matter of first impression which choice-of-law rules should apply when a bankruptcy court sitting in one state is resolving a bankruptcy claim arising from a state-law action previously filed in another state. The court ruled that: (i) where a claim is wholly derived from another legal claim pending in a parallel nonbankruptcy proceeding in another state; and (ii) where the pending original claim was filed in a court prebankruptcy, the bankruptcy court must apply the choice-of-law rules of the state where the underlying prepetition claim was filed (in this case, Connecticut).

AVOIDANCE ACTIONS/TRUSTEE'S AVOIDANCE AND STRONG-ARM POWERS

In Senior Transeastern Lenders v. Official Committee of Unsecured Creditors (In re TOUSA, Inc.), 680 F.3d 1298 (11th Cir. 2012), the Eleventh Circuit ruled that the bankruptcy court's findings that subsidiaries of residential construction company TOUSA, Inc., did not receive reasonably equivalent value in exchange for liens they granted to secure financing to fund the parent company's settlement with its joint-venture lenders were not clearly erroneous. Accordingly, the Eleventh Circuit held, those findings supported the bankruptcy court's determination that the transaction was a fraudulent transfer under section 548(a)(1)(B) of the Bankruptcy Code. The TOUSA litigation has been closely followed by the loan market because of the significant implications for both lenders and borrowers when structuring loan transactions with comparable structural features, such as upstream guarantees with standard "savings clauses."

Reconciling discordant orders issued in the same chapter 11 case, a Delaware bankruptcy court ruled in Industrial Enterprises of America v. Burtis (In re Pitt Penn Holding Co., Inc.), 2012 WL 204095 (Bankr. D. Del. Jan. 24, 2012), that the two-year statutory "look-back" period during which a fraudulent transfer may be avoided pursuant to section 548 of the Bankruptcy Code cannot be "equitably tolled."

BANKRUPTCY-COURT POWERS/JURISDICTION

Putting it mildly, the U.S. Supreme Court's 2011 ruling in Stern v. Marshall, 132 S. Ct. 56 (2011), cast a wrench into the day-to-day operation of bankruptcy courts scrambling to deal with a deluge of challenges - strategic or otherwise - to the scope of their "core" authority to issue final orders and judgments on a wide range of disputes. In Stern, the Court ruled that, to the extent that 28 U.S.C. § 157(b)(2)(C) purports to confer authority on a bankruptcy court to finally adjudicate a state-law counterclaim against a creditor that filed a proof of claim, the provision is constitutionally invalid. The mayhem among bankruptcy and appellate courts continued throughout 2012.

In Onkyo Electronics v. Global Technovations Inc. (In re Global Technovations Inc.), 694 F.3d 705 (6th Cir. 2012), the Sixth Circuit became the first court of appeals to consider whether, in the aftermath of Stern, a bankruptcy court has authority to enter a final judgment in an action seeking to avoid a fraudulent transfer. The Sixth Circuit held that the bankruptcy court did have authority to do so because the creditor had filed a proof of claim. According to the court, it was "crystal clear that the bankruptcy court had constitutional jurisdiction under Stern to adjudicate whether the sale [to the debtor of a subsidiary of Onkyo] was a fraudulent transfer" because Onkyo's proof of claim could not be resolved without addressing the fraudulent-transfer question. Thus, the Sixth Circuit wrote, this "case is fundamentally unlike [Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989)], where the bankruptcy estate reached out to file a fraudulent-transfer claim against a party who had filed no claim against the estate."

However, the Sixth Circuit also stated that "[w]hat is not crystal clear is whether the bankruptcy court had jurisdiction under Stern to make the additional finding that Onkyo was a 'good-faith transferee' and a 'good-faith obligee' under [the Florida Uniform Fraudulent Transfer Act]." The bankruptcy court never reached the issue below because it disallowed Onkyo's claim for the balance of the purchase price in its entirety. The Sixth Circuit held that even though a good-faith-transferee determination was not necessary to resolve Onkyo's proof of claim, the bankruptcy court nonetheless had authority to make the determination. According to the Sixth Circuit, it did not read Stern to require a court "to determine, in advance, which facts will ultimately prove strictly necessary to resolve a creditor's proof of claim." Thus, the mere possibility that a claim dispute will be resolved in a way that requires the bankruptcy court to address unrelated matters does not deprive the court of authority to issue a final ruling.

The Sixth Circuit reprised its role as interpreter of Stern in Waldman v. Stone, 698 F.3d 910 (6th Cir. 2012). In a surprising ruling that reinvigorated the ongoing debate about Stern's scope, the Sixth Circuit adopted a broad view of the case, holding that the limitations imposed on bankruptcy courts by Article III of the Constitution cannot be waived by a party's failure to object at the trial-court level. In addition to rejecting the waiver principle as a basis for bankruptcy courts to issue final judgments in certain proceedings, the Sixth Circuit suggested that a "statutory gap" in 28 U.S.C. § 157 may prevent a bankruptcy court from issuing proposed findings of fact and conclusions of law in core matters. The decision renewed uncertainty regarding the constitutional limits of a bankruptcy court to adjudicate both core and noncore claims.

In Executive Benefits Insurance Agency, Inc. v. Arkison (In re Bellingham Insurance Agency, Inc.), 2012 WL 6013836 (9th Cir. Dec. 4, 2012), the Ninth Circuit ruled that, even though federal law empowers bankruptcy judges to enter final judgments in fraudulent-conveyance actions against a "nonclaimant" (i.e., someone who has not filed a proof of claim), the U.S. Constitution forbids entry of a final order because those claims do not fall within the "public rights exception." However, the court explained, defendants in such avoidance proceedings may (and in this case did) consent to the entry of a final judgment by the bankruptcy court, even if that consent was implied from the defendant's failure to assert its right to entry of final judgment by an Article III court. In addition, the Ninth Circuit emphasized that a bankruptcy court may still hear and make recommendations regarding any statutorily "core" proceedings in which the court lacks the authority to enter a final judgment.

In KHI Liquidation Trust v. Wisenbaker Builder Servs., Inc. (In re Kimball Hill, Inc.), 480 B.R. 894 (Bankr. N.D. Ill. 2012), the court suggested that bankruptcy courts do have the authority to enter final judgments in both fraudulent-transfer and preference litigation, whether or not: (i) the defendant filed a proof of claim; (ii) the fraudulent-transfer and preference claims are related to those initial claims; and (iii) the parties consented to final adjudication by the bankruptcy court. The court concluded that the vast majority of the Supreme Court's decision in Stern (and the ruling in Ortiz v. Aurora Health Care, Inc. (In re Ortiz), 665 F.3d 906 (7th Cir. 2011), by which the Kimball Hill court was bound), was mere dicta and therefore not controlling authority for cases differing from the unique set of facts in Stern.

According to the Kimball Hill court, the proceeding before it did not involve counterclaims and was in no way "steeped in state law." Furthermore, the court wrote, it "[did] not share anything in common with the proceedings that Stern and Ortiz held [were] unconstitutional other than that they are all adversary proceedings in a bankruptcy case," a commonality that was "not sufficient to expand [Stern's] explicitly narrow holding." The court remarked that "[a]s the right to avoid a fraudulent transfer is steeped in bankruptcy law, the bankruptcy court's entering final orders on the proceeding does not chip away at the authority that the Constitution vested to the Article III courts."

A Florida bankruptcy court ruled in In re Pearlman, 462 B.R. 849 (Bankr. M.D. Fla. 2012), that "substantive consolidation" - the merging of the assets, liabilities, and creditors of related entities - is purely a bankruptcy remedy and that a bankruptcy court does not have the power to consolidate the estate of a debtor in bankruptcy with the assets and affairs of a nondebtor. In doing so, the court staked out a position on a contentious issue that has created a widening rift among bankruptcy and appellate courts regarding the scope of a bankruptcy court's jurisdiction over nondebtor entities. For example, in In re LLS America, LLC, 2012 WL 2042503 (B.A.P. 9th Cir. June 5, 2012), a bankruptcy appellate panel affirmed a bankruptcy-court order substantively consolidating the estates of debtor and nondebtor entities without comment regarding the power of the court to order the remedy.

In Continental Ins. Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), 671 F.3d 1011 (9th Cir. 2012), the Ninth Circuit ruled that a bankruptcy court has discretion, even in a "core" proceeding, to decline to enforce an otherwise valid and applicable arbitration provision, but only if arbitration would conflict with the underlying purposes of the Bankruptcy Code.

CHAPTER 11 PLANS

In RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012), a unanimous U.S. Supreme Court upheld a ruling by the Seventh Circuit denying confirmation of a "cramdown" chapter 11 plan that contemplated the sale of encumbered assets free and clear of all liens without giving a secured creditor the right to credit-bid its claim in connection with the sale. By its ruling, the Supreme Court resolved a circuit split on the proper application of the "indubitable equivalent" prong of section 1129(b)(2)(A) of the Bankruptcy Code.

In a prelude (and a corollary) to the highly anticipated ruling in RadLAX, the Seventh Circuit in In re River East Plaza, LLC, 669 F.3d 826 (7th Cir. 2012), affirmed a bankruptcy court's ruling that a debtor could not "cram down" a chapter 11 plan over the objection of an undersecured creditor which had made a section 1 1 11(b) election by substituting a lien on 30-year U.S. Treasury bonds as the "indubitable equivalent" of the creditor's mortgage lien on the property.

"Mootness" is a doctrine that precludes a reviewing court from reaching the underlying merits of a controversy. In federal courts, an appeal can be either constitutionally or equitably moot. Constitutional mootness is derived from Article III of the U.S. Constitution, which limits the jurisdiction of federal courts to actual cases or controversies and, in furtherance of the goal of conserving judicial resources, precludes adjudication of cases that are hypothetical or merely advisory. In contrast, "equitable mootness" bars adjudication of an appeal when a comprehensive change of circumstances occurs such that it would be inequitable for a reviewing court to address the merits of the appeal. In bankruptcy cases, equitable mootness is often invoked in an effort to preclude appellate review of an order confirming a chapter 11 plan.

In In re Thorpe Insulation Co., 671 F.3d 980 (9th Cir. 2012), amended and superseded on denial of rehearing en banc, 677 F.3d 869 (9th Cir. 2012), the Ninth Circuit, in a matter of first impression, held that an appeal by certain nonsettling asbestos insurers of an order confirming a chapter 11 case was not equitably moot. According to the Ninth Circuit, the insurers used due diligence in seeking a stay, the plan had not been substantially consummated (as defined in section 1101 of the Bankruptcy Code), remedies short of reversing confirmation would not inequitably affect the interests of third-party asbestos claimants or a lender that had extended credit to the reorganized debtor, and a remedy could be fashioned for the insurers by a multitude of options other than complete plan reversal.

In In re Philadelphia Newspapers, LLC, 690 F.3d 161 (3d Cir. 2012), the Third Circuit held that the foremost consideration in ruling on a challenge to plan confirmation on the basis of equitable mootness is "whether allowing the appeal to go forward will undermine the plan, and not merely whether the plan has been substantially consummated." According to the Third Circuit, the district court erred by: (i) finding equitable mootness relying only on the plan's substantial consummation under the Bankruptcy Code's definition; (ii) failing to perform an analysis of whether a ruling favorable to the appellants would upset the confirmed plan; and (iii) faulting the appellants for not seeking a stay, without explaining whether a stay was critical, given the progression of the debtors' bankruptcy cases.

In In re Charter Communications, Inc., 691 F.3d 476 (2d Cir. 2012), the Second Circuit deepened a split between the circuits with respect to the standard of review and burden of proof to be applied in equitable-mootness cases. The court held that once a chapter 11 plan has been substantially consummated, an appeal is presumed to be equitably moot unless the appellant can demonstrate that it has met all five of the criteria delineated in its previous ruling in Frito-Lay, Inc. v. LTV Steel Co. (In re Chateaugay Corp.), 10 F.3d 944 (2d Cir. 1993). By appearing to abandon the balancing approach employed by other circuits in this context, the Second Circuit now stands alone in presuming that an appeal is equitably moot following substantial consummation of a chapter 11 plan. This deepening rift may be a compelling invitation to review by the U.S. Supreme Court.

The strategic importance of classifying claims and interests under a chapter 11 plan is sometimes an invitation for creative machinations designed to muster adequate support for confirmation of the plan. A prominent bone of contention in the ongoing plan-classification dispute concerns the legitimacy of separately classifying similar, but arguably distinct, kinds of claims in an effort to create an accepting impaired class or to prevent a dissenting creditor from dominating a class because its claim is so substantial that the creditor can ensure that the class votes to reject a plan. Sometimes referred to as class "gerrymandering," this practice was the subject of a ruling handed down by a bankruptcy appellate panel in In re Loop 76, LLC, 465 B.R. 525 (B.A.P. 9th Cir. 2012). The panel affirmed a bankruptcy-court ruling that an unsecured-deficiency claim should be classified separately from the claims of other unsecured creditors because the undersecured creditor had recourse to a guarantee for payment of its deficiency claim, such that the claims were not substantially similar.

In In re 18 RVC, LLC, 2012 WL 5336733 (Bankr. E.D.N.Y. Oct. 22, 2012), the court ruled that the existence of a personal guarantee for an unsecured claim of a partially secured lender is insufficient to support separate classification of that claim under section 1122(a) of the Bankruptcy Code as one that is not "substantially similar" to all other unsecured claims. The ruling was the first outside the Ninth Circuit to decline to follow Loop. In doing so, the 18 RVC court agreed with the reasoning articulated in In re 4th Street East Investors, Inc., 2012 WL 1745500 (Bankr. C.D. Cal. May 15, 2012), the first decision rejecting Loop, where the bankruptcy court held that the existence of a nondebtor guarantee is an insufficient basis to separately classify unsecured claims.

In Federal National Mortgage Assoc. v. Village Green I GP, 2012 WL 6045896 (W.D. Tenn. Dec. 5, 2012), the district court ruled that a bankruptcy court improperly rejected outright the "doctrine of artificial impairment," which refers to the manipulation of classes of claims in order to artificially create an accepting class of impaired claims. Reversing and remanding the decision below, the district court concluded that the determining factor should be not whether the impairment was artificial, but whether the impairment was without justification. The court rejected the majority view that artificial impairment "runs afoul" of the requirements for chapter 11 confirmation, including sections 1129(a)(3) and 1129(a)(10).

In In re American Capital Equipment, LLC, 688 F.3d 145 (3d Cir. 2012), the Third Circuit held as a matter of first impression that a bankruptcy court may, in certain circumstances, resolve confirmation issues at the disclosure-statement hearing. The court of appeals affirmed a bankruptcy court's ruling at the disclosure-statement stage that: (i) a chapter 11 plan did not satisfy the Bankruptcy Code's requirements that a plan be "feasible" and proposed in "good faith"; and (ii) the debtors' chapter 11 cases should be converted to chapter 7 liquidations due to the plan's "patent unconfirmability."

In In re Federal-Mogul Global Inc., 684 F.3d 355 (3d Cir. 2012), the Third Circuit held that a debtor could assign insurance policies to an asbestos trust established under section 524(g) of the Bankruptcy Code, notwithstanding anti-assignment provisions in the policies and applicable state law. Like the courts below, the Third Circuit determined that it had already held in In re Combustion Engineering, Inc., 391 F.3d 190 (3d Cir. 2004), that section 1123 of the Bankruptcy Code preempts anti-assignment provisions which would otherwise bar the transfer of insurance rights to an asbestos trust. The Third Circuit rejected the argument that section 1123's preemption scope should be based on section 1142 of the Bankruptcy Code (providing that the debtor shall implement the plan "[n]otwithstanding any otherwise applicable nonbankruptcy law, rule, or regulation relating to financial condition") and the Ninth Circuit's ruling in Pac. Gas & Elec. Co. v. California ex rel. California Dept. of Toxic Substances Control, 350 F.3d 932 (9th Cir. 2003). The court saw no reason to read sections 1123 and 1142 coextensively. In addition to finding Pacific Gas distinguishable, the Third Circuit was "unconvinced" that sections 1123 and 1142 are so similar that they must be read together.

In In re Caviata Attached Homes, LLC, 481 B.R. 34 (B.A.P. 9th Cir. 2012), the court considered as a matter of first impression whether unforeseen circumstances prevented a chapter 11 debtor from complying with the terms of a chapter 11 plan confirmed in a previous chapter 11 case. Section 1127(b) of the Bankruptcy Code prohibits the modification of a substantially consummated plan. Even so, some courts have held that serial chapter 11 filings are not per se impermissible and that a second plan may modify the first plan where there has been an unforeseeable or unanticipated change in circumstances.

In Caviata, the court considered an appeal from a bankruptcy-court order dismissing a serial chapter 1 1 filing 15 months after confirmation of a plan in the debtor's previous chapter 11 case. The appellate panel cautioned that "[e]ven extraordinary and unforeseeable changes will not support a new Chapter 11, if these changes do not substantially impair the debtor's performance under the confirmed plan." It left undisturbed the bankruptcy court's finding that a decline in the U.S. economy between 2010 and 2011 was not an unforeseeable changed circumstance that substantially impaired the debtor's ability to perform under its confirmed chapter 11 plan.

CLAIMS/DEBT TRADING

A Delaware bankruptcy-court ruling in 2012 reignited the debate concerning whether sold or assigned claims can be subject to disallowance under section 502(d) of the Bankruptcy Code on the basis of the seller's receipt of a voidable transfer. In In re KB Toys, Inc., 470 B.R. 331 (Bankr. D. Del. 2012), the court rejected as unworkable the distinction between a sale and an assignment of a claim for purposes of disallowance that was drawn by the district court in Enron Corp. v. Springfield Associates, L.L.C. (In re Enron Corp.), 379 B.R. 425 (S.D.N.Y. 2007) ("Enron II"), vacating Enron Corp. v. Springfield Associates, L.L.C. (In re Enron Corp.), 2005 WL 3873893 (Bankr. S.D.N.Y. Nov. 28, 2005), and Enron Corp. v. Avenue Special Situations Fund II, LP (In re Enron Corp.), 340 B.R. 180 (Bankr. S.D.N.Y. 2006).

In KB Toys, the bankruptcy court ruled that several transferred trade claims should be disallowed under section 502(d) because the transferors had received voidable preferences. According to the court, "The plain language, legislative history, and decisional law support the view that a claim in the hands of a transferee has the same rights and disabilities as the claim had in the hands of the original claimant. Disabilities attach to and travel with the claim." The court also wrote that "the assertion that subjecting transferred claims to § 502(d) disallowance would cause disruption in the claims trading market is a hobgoblin without a house to haunt."

In Longacre Master Fund, Ltd. v. ATS Automation Tooling Systems Inc., 2012 WL 4040176 (2d Cir. Sept. 14, 2012), the Second Circuit handed down an unpublished ruling that might have addressed the claims-trading section 502(d) controversy head-on but did not. In Longacre, the debtor objected to a traded claim (among others) under section 502(d) for the purpose of preserving its ability to prosecute preference actions associated with the claim. The objection was ultimately settled, but the buyer of the claim sued the seller, arguing that the claim had been "impaired," thereby triggering the seller's obligation under the claims-assignment agreement to repurchase the claim.

The district court ruled in favor of the seller, reasoning that the debtor's objection under section 502(d) did not amount to "impairment" under the agreement because it merely preserved the debtor's right to object, rather than being "substantive." Moreover, the district court wrote, "because the Agreement [e]ffected a sale and not a pure assignment of the Claim, for the reasons stated in [Enron II], no section 502(d) objection (even if one were to have been made) would have constituted an Impairment in the first instance." The court also determined that the assignor had not breached its representations and warranties regarding the absence of potential preference actions because it had no knowledge of such actions.

The Second Circuit vacated the judgment, ruling that "nothing in the language of [the agreement] requires that the objection be meritorious" to constitute impairment triggering the repurchase obligation. The court also faulted the district court's decision regarding the absence of any breach of warranty, finding that a disputed material issue of fact existed as to the assignor's knowledge of a possible preference action and related objection. The Second Circuit briefly discussed whether the agreement constituted a sale rather than an assignment. However, it did not rule on this issue, nor did it address the district court's observations regarding Enron II and the purported protection from disallowance under section 502(d) of claims that have been sold rather than assigned.

CREDITOR RIGHTS

In Akanthos Capital Mgmt., LLC v. CompuCredit Holdings Corp., 677 F.3d 1286 (1 1th Cir. 2012), the Eleventh Circuit reversed a district-court decision declining to dismiss claims brought by noteholders under Georgia's Uniform Fraudulent Transfers Act ("UFTA") to avoid fraudulent transfers allegedly made by the issuing company. The primary issue confronting the Eleventh Circuit involved the circumstances under which a "no-action" clause in a bond indenture precludes noteholders from taking legal action against a debt issuer. In enforcing the terms of the no-action clause to bar noteholders from bringing UFTA claims, the court refused to deviate from legal precedent that generally discourages efforts to circumvent the provisions of a contract and refused to alter the terms of an agreement in cases not involving an indenture trustee's demonstrated conflict of interest.

In In re Windmill Durango Office, LLC, 481 B.R. 51 (B.A.P. 9th Cir. 2012), a bankruptcy appellate panel ruled that a bankruptcy court did not abuse its discretion in denying, for lack of "cause" under Bankruptcy Rule 3018(a), the motion of a secured creditor that had been assigned another creditor's claim, whereby the secured creditor sought to withdraw the assignor's vote in favor of the debtor's chapter 11 plan and to submit a substitute ballot rejecting the plan. The secured creditor had admittedly purchased the claim as a means to block confirmation of a plan providing for cramdown treatment of its secured claim. The bankruptcy court below explained that it is not appropriate for creditors "to wait 'til the plans [were] balloted and then decide what claims [they were] going to buy" and that the bank's attempt to change its vote to block confirmation was improperly motivated and "did the process violence." Accordingly, the bankruptcy court denied the bank's motion to change its vote for failure to show "cause" under Rule 3018(a). The appellate panel affirmed.

CROSS-BORDER BANKRUPTCY CASES

October 17, 2012, marked the seven-year anniversary of the effective date of chapter 15 of the Bankruptcy Code. Governing cross-border bankruptcy and insolvency cases, chapter 15 is patterned after the Model Law on Cross- Border Insolvency (the "Model Law"), a framework of legal principles formulated by the United Nations Commission on International Trade Law in 1997 to deal with the rapidly expanding volume of international insolvency cases. The Model Law has now been adopted in one form or another by 19 nations or territories. There were several notable rulings handed down in 2012 in connection with cross-border bankruptcy cases.

For example, addressing an apparent matter of first impression concerning the ability of a U.S. bankruptcy court presiding over a chapter 15 case to examine foreign-court decisions for the purpose of determining whether litigants received their due-process rights, the court in SNP Boat Service S.A. v. Hotel Le St. James, 2012 WL 1355550 (S.D. Fla. Apr. 18, 2012), concluded that the bankruptcy court abused its discretion in ordering discovery for the purpose of examining whether a creditor's interests were sufficiently protected in a French sauvegarde proceeding. It accordingly reversed the bankruptcy court's dismissal of the debtor's chapter 15 case as a sanction for failing to comply with its discovery orders.

A New York district court held in CT Investment v. Carbonell and Grupo Costamex, 2012 WL 92359 (S.D.N.Y. Jan. 11, 2012), that because a U.S. bankruptcy court had recognized a foreign debtor's Mexican insolvency proceeding under chapter 15, "comity" should be extended to the Mexican insolvency court's orders by staying litigation commenced in the U.S. district court by the Mexican debtor's secured creditors seeking to recover on guarantees issued by the debtor's nondebtor affiliates. The court concluded that the Mexican court order staying collection actions against nondebtor guarantors was not "manifestly contrary" to U.S. public policy. The court reached this conclusion in light of, among other things, several U.S. bankruptcy-court rulings extending the automatic stay, under appropriate circumstances, to nondebtor parties in order to assist in and maintain the integrity of the administration of a debtor's bankruptcy case.

A contrary conclusion was reached by the bankruptcy court in In re Vitro S.A.B. de C.V., 473 B.R. 117 (Bankr. N.D. Tex. 2012). In Vitro, one of several court rulings involving the same chapter 15 debtor, the court ruled that releases of nondebtor guarantors included in the Mexican plan of reorganization of Mexican glassmaker Vitro S.A.B. de C.V. ("Vitro") were unenforceable as being contrary to U.S. public policy. On direct appeal to the Fifth Circuit, the court affirmed, ruling in Ad Hoc Group of Vitro Noteholders v. Vitro S.A.B. de C.V. (In re Vitro S.A.B. de C.V.), 2012 WL 5935630 (5th Cir. Nov. 28, 2012), that such releases could be enforceable in the U.S. under section 1507 of the Bankruptcy Code as a form of "additional assistance" to a foreign representative in a foreign bankruptcy proceeding recognized by a U.S. bankruptcy court under chapter 15 of the Bankruptcy Code, but only under "exceptional circumstances" not present in the case before it.

In In re Metcalfe & Mansfield Alternative Investments, 421 B.R. 685 (Bankr. S.D.N.Y. 2012), the court, by way of "additional assistance" in a chapter 15 case involving a Canadian debtor, enforced a Canadian court's order confirming a restructuring plan that contained nondebtor releases and injunctions, even though it was uncertain whether a U.S. court would have approved the releases and injunctions in a case under chapter 7 or 11 of the Bankruptcy Code. The court reasoned that such uncertainty was of little consequence in the case before it, which involved not the propriety of nondebtor injunctions and releases in a plenary bankruptcy case, but rather a request to enforce a foreign judgment in a chapter 15 case. The court concluded that "principles of enforcement of foreign judgments and comity in chapter 15 cases strongly counsel approval of enforcement in the United States of the third-party non-debtor release and injunction provisions included in the Canadian Orders, even if those provisions could not be entered in a plenary chapter 11 case."

In In re Vitro, S.A.B. de C.V., 470 B.R. 408 (N.D. Tex. 2012), the district court affirmed a bankruptcy court's decision that an individual appointed by foreign debtor Vitro, rather than the Mexican bankruptcy court, could serve as Vitro's "foreign representative" under chapter 15 of the Bankruptcy Code and was thus authorized to commence a chapter 15 case on Vitro's behalf. The Fifth Circuit later upheld the ruling on appeal. See In re Vitro, S.A.B. de C.V., 2012 WL 5935630 (5th Cir. Nov. 28, 2012).

In In re Vitro Asset Corp., 2012 BL 317004 (Bankr. N.D. Tex. Dec. 4, 2012), the court ruled that the decision by Vitro to shift property secretly out of the U.S. and to reincorporate a number of subsidiaries offshore amounted to fraud under U.S. law justifying the commencement of involuntary bankruptcy cases against the subsidiaries. The court held that the actions, including the reincorporation of five subsidiaries in the Bahamas and failure to disclose information to U.S. courts in an effort to frustrate a bid by a group of hedge-fund bondholders to push Vitro's U.S. subsidiaries into bankruptcy, constituted "special circumstances" allowing creditors to file an involuntary bankruptcy case against a company "when there is fraud, trick, artifice, or scam by an alleged debtor." The court also ruled that, on the basis of rulings handed down by New York State courts, the bondholders' claims were not subject to bona fide dispute within the meaning of section 303(b)(1) of the Bankruptcy Code.

In re Elpida Memory, Inc., 2012 WL 6090194 (Bankr. D. Del. Nov. 20, 2012), the court ruled that, when evaluating a transfer of assets located in the U.S. as part of a "global" transaction previously approved by a foreign court in a bankruptcy proceeding recognized under chapter 15 of the Bankruptcy Code, the U.S. bankruptcy court must review the transaction under the "business judgment" standard applied to a proposed transfer by a bankruptcy trustee outside the ordinary course of the debtor's business under section 363(b) of the Bankruptcy Code. According to the court, requiring a U.S. bankruptcy court to defer in all instances to a foreign-court decision would "gut" section 1520 of the Bankruptcy Code, which makes section 363 applicable to proposed transfers of U.S. assets.

In In re Lee, 472 B.R. 156 (Bankr. D. Mass. 2012), the court, addressing an apparent matter of first impression, ruled that a foreign representative bears the initial burden of establishing that he is entitled to turnover of the debtor's U.S. assets under sections 1521(a)(5) and 1521(b) of the Bankruptcy Code, as well as the initial burden of demonstrating that the interests of the foreign debtor and creditors are sufficiently protected in connection with such relief, as provided in section 1522. However, the court also held that the ultimate burden of establishing the absence of sufficient protection rests on the parties opposing the relief.

In Trillium (Nelson) Properties Ltd v Office Metro Ltd [2012] EWHC 1191 (Ch) (09 May 2012), the English High Court for the first time ruled on the requirements governing the existence of an "establishment" under the EC Regulation. Under the EC Regulation - like the Model Law and chapter 15 - "main" insolvency proceedings may be commenced on behalf of a debtor only in the single jurisdiction in which the debtor's "centre of main interests" is located. Where a main proceeding has been instituted in one EU Member State, the EC Regulation provides that "secondary" proceedings may be commenced in another Member State if the debtor "possesses an establishment within the territory of that other Member State." "Establishment" is defined by the EC Regulation as "any place of operations where the debtor carries out non-transitory economic activity with human means and goods." In Trillium, the English court ruled that a foreign debtor whose main insolvency proceedings had been opened in Luxembourg carried on no more than "transitory" functions in the U.K. that did not amount to "economic activity" necessary to create an "establishment."

In Rubin v. Eurofinance SA [2012] UKSC 46 (24 Oct. 2012) and New Cap Re v. AE Grant [2012] UKSC 46 (24 Oct. 2012), the U.K. Supreme Court handed down judgments in two cases where insolvency practitioners were seeking to enforce foreign (non-EU) court judgments arising from insolvency proceedings in their jurisdictions (the U.S. and Australia) against English defendants in English courts. The majority held that Cambridge Gas Transportation Corporation v. Official Committee of Unsecured Creditors of Navigator Holdings Plc [2007] 1 AC 508, which previously promoted the idea of universality of recognition in insolvency proceedings, was wrongly decided. Instead, the Supreme Court held that insolvency judgments are subject to standard common-law principles relating to recognition and enforcement. According to the court, a foreign judgment cannot be enforced under either the Cross-Border Insolvency Regulations 2006 (enacting the Model Law in the U.K.) or section 426 of the Insolvency Act because, in the court's view, neither expressly provides for the enforcement of judgments. The decision will make it more difficult to enforce foreign insolvency judgments in England and may lead to an increase in the volume of parallel insolvency proceedings filed in English courts in cross-border bankruptcy cases (e.g., "nonmain" proceedings under the Model Law) for the purpose of obtaining recognition of (and enforcing) such judgments.

ESTATE PROPERTY

In Lowry v. Croft (In re Croft), 2012 BL 321154 (W.D. Tex. Dec. 10, 2012), the district court considered, as a matter of first impression, whether the right to appeal a judgment entered prior to bankruptcy on a claim asserted against the debtor is property of the estate, as defined in section 541(a) of the Bankruptcy Code, and thus subject to sale by a bankruptcy trustee under section 363(b). The court ruled that such a "defensive appellate right" is a salable asset of the estate. In doing so, the court was persuaded by In re Mozer, 302 B.R. 892 (C.D. Cal. 2003), in which the district court came to a similar conclusion, and rejected the contrary decision in In re Morales, 403 B.R. 629 (Bankr. N.D. Iowa 2009).

EXECUTORY CONTRACTS AND UNEXPIRED LEASES

The Seventh Circuit held as a matter of first impression in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 372 (7th Cir. 2012), cert. denied, 2012 WL 4812510 (Dec. 10, 2012), that when a trademark license is rejected in bankruptcy, the licensee does not lose the ability to use any licensed intellectual property. In doing so, the court expressly rejected the holding in Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), providing what appeared to be a compelling invitation to U.S. Supreme Court review of this important issue to resolve the resulting split in the circuits. However, the Supreme Court declined to hear the case December 10, 2012, when it denied a petition for a writ of certiorari.

In In re Spansion, Inc., 2012 WL 6634899 (3d Cir. Dec. 21, 2012), the debtor, a computer-memory manufacturer, sued Apple Inc. ("Apple") and Samsung Electronics Co., Ltd., for patent violations. Apple settled with the debtor in an agreement whereby the debtor promised to dismiss the complaint as to Apple and to not sue Apple in the future for use of the intellectual property involved. The debtor subsequently filed for chapter 11 protection and rejected the settlement agreement. Apple claimed that the agreement provided it with an intellectual property "license" entitled to the protections of section 365(n) of the Bankruptcy Code. The Third Circuit upheld the lower courts' rulings that Apple's rights under the agreement were protected by section 365(n). According to the Third Circuit, " '[A] license . . . [is] a mere waiver of the right to sue by the patentee,' " such that a covenant not to sue and a license are effectively equivalent. Because the settlement agreement provided Apple with such a license, the court concluded that the debtor's rejection of the agreement triggered Apple's right to elect to retain its licensing rights under section 365(n).

Courts disagree as to whether the rights of a nondebtor lessee or sublessee under section 365(h)(1) of the Bankruptcy Code to remain in possession are effectively extinguished if the leased real property - or the lease itself, rather than being rejected - is sold free and clear of any "interest" under section 363(f). In In re Zota Petroleums, LLC, 482 B.R. 154 (Bankr. E.D. Va. 2012), the bankruptcy court distinguished the Seventh Circuit's arguably contrary decision in Precision Industries, Inc. v. Qualitech Steel SBQ, 327 F.3d 537 (7th Cir. 2003), ruling that "[t]he rights of the tenant may not be extinguished by a § 363 sale; to hold to the contrary would give open license to debtors to dispossess tenants by utilizing the § 363 sale mechanism."

In In re Hostess Brands, Inc., 477 B.R. 378 (Bankr. S.D.N.Y. 2012), the court ruled that, where a collective bargaining agreement has expired prebankruptcy, the agreement cannot be assumed or rejected under section 1113 of the Bankruptcy Code, which governs assumption or rejection of bargaining agreements in bankruptcy. Instead, the parties are left to the "fallback regime" of otherwise applicable law, including the National Labor Relations Act. As a consequence, the court dismissed the debtors' motion under section 1113 to reject an expired bargaining agreement for lack of subject-matter jurisdiction. However, the court separately granted the debtors' motion pursuant to section 1113(e) to implement interim changes to the terms of expired agreements and granted their motion to reject collective bargaining agreements that had not expired.

FILING ELIGIBILITY

In In re Northern Mariana Islands Retirement Fund, Case No. 12-00003 (Dist. N. Marianas June 13, 2012), the court ruled that the Northern Mariana Islands Retirement Fund, a significantly underfunded public-employee pension plan expected to fail in 2014, is not eligible to be a chapter 11 debtor. The case is noteworthy because it is the first time that a court has addressed whether a public pension fund with significantly underfunded defined-benefit liabilities can file for bankruptcy protection. The ruling turned on the fund's lack of autonomy and its limited function, leading the court to conclude that the fund was a "governmental unit" rather than a "person" eligible for bankruptcy relief.

FINANCIAL CONTRACTS/SETOFFS

"Safe harbors" in the Bankruptcy Code designed to insulate nondebtor parties to financial contracts from the consequences of a bankruptcy filing by the debtor counterparty have been the focus of a considerable amount of scrutiny in recent years, including 2012. Some of these rulings addressed the "settlement payment" defense to avoidance of a transfer provided by section 546(e) of the Bankruptcy Code.

For example, in AP Services LLP v. Silva, 483 B.R. 63 (S.D.N.Y. 2012), the court held that payments made in connection with a leveraged buyout to holders of privately held securities were safe-harbored under section 546(e), notwithstanding the fact that the payments passed directly from the purchaser to the seller rather than through a financial intermediary. The decision is consistent with the trend among the federal circuit courts of appeal interpreting section 546(e) broadly. See In re Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329 (2d Cir. 2011); In re Plassein Int'l Corp., 590 F.3d 252 (3d Cir. 2009); In re QSI Holdings, Inc., 571 F.3d 545 (6th Cir. 2009); Contemporary Indus. Corp. v. Frost, 564 F.3d 981 (8th Cir. 2009).

In Lightfoot v. MXEnergy Electric (In re MBS Management Services, Inc.), 690 F.3d 352 (5th Cir. 2012), the Fifth Circuit ruled that an agreement between a property-management company and a power company for the purchase of "full electric requirements" for specified properties was a "forward contract" within the meaning of section 101(25) of the Bankruptcy Code. As a consequence, the management company's payments to the power company pursuant to the agreement within 90 days of the power company's chapter 11 filing were exempt from preference recovery under section 546(e), despite the contention that the agreement did not specify exact quantities and delivery dates. According to the Fifth Circuit, neither the statutory definition of "forward contract" nor section 546(e) contains limitations regarding a specific quantity and delivery date.

In In re Quebecor World (USA) Inc., 480 B.R. 468 (S.D.N.Y. 2012), the district court ruled that payments made to redeem outstanding notes by a company on the verge of bankruptcy qualified as "settlement payments" under section 546(e) and thus could not be clawed back in an avoidance action. The court upheld the bankruptcy court's application of the Second Circuit's decision in Enron and confirmed that section 546(e) broadly encompasses cash transfers made to "complete a securities transaction."

MUNICIPAL DEBTORS

The contrasts between chapter 9 and other chapters of the Bankruptcy Code were highlighted in a ruling handed down in 2012 by the Alabama bankruptcy court presiding over the largest municipal bankruptcy in U.S. history. In In re Jefferson County, Alabama, 474 B.R. 228 (Bankr. N.D. Ala. 2012), the court denied a state-court-appointed receiver's request to retain control of the debtor's sewer system, holding that the bankruptcy court had exclusive jurisdiction over the property and that the automatic stays imposed by sections 362 and 922 of the Bankruptcy Code precluded continuation of the receiver's stewardship. The bankruptcy court also refused to abstain from hearing the bankruptcy case or to modify the automatic stays. However, the court ruled that the stays did not preclude the continuation of payments to warrant holders from the sewer system's pledged revenue stream, net of any necessary operating costs.

In In re City of Stockton, California, 478 B.R. 8 (Bankr. E.D. Cal. 2012), the court held that: (i) the debtor city could unilaterally reduce the benefits of its retirees without offending the Contracts Clause of the U.S. Constitution (even where those benefits otherwise may be considered contractual in nature under state law); and (ii) the court was not permitted to enjoin the debtor from implementing the benefit reductions due to the express limitations on a bankruptcy court's jurisdictional mandate in chapter 9 cases. The ruling is an additional blow to the rights of municipal employees and retirees in the wake of the ruling in In re City of Vallejo, California, 432 B.R. 262 (E.D. Cal. 2010). In Vallejo, the district court affirmed a bankruptcy-court ruling that section 1113 of the Bankruptcy Code does not apply in chapter 9, potentially making it easier for a municipal debtor to reject a collective bargaining agreement.

Several courts in Alabama have considered the issue of eligibility to file for chapter 9 relief under Alabama law. In another ruling involving Jefferson County, Alabama, In re Jefferson County, Ala., 469 B.R. 92 (Bankr. N.D. Ala. 2012), the court ruled that a municipal debtor was eligible for chapter 9 relief even though it issued sewer warrants rather than bonds. According to the court, resort to a bankruptcy court "is not constrained by the types of debts outstanding on the day a bankruptcy case is initiated."

The Jefferson County ruling contravened an earlier ruling by another Alabama bankruptcy judge, who held that the City of Prichard, Alabama, was not eligible to be a chapter 9 debtor because it did not have outstanding bonds. See In re City of Prichard, Ala., No. 1:09-BK-15000 (Bankr. S.D. Ala. Aug. 31, 2010). Prichard was appealed to the district court, which asked the Alabama Supreme Court to weigh in on the question in May 2011.

The Alabama Supreme Court did so in City of Prichard v. Balzer, 95 So. 3d 1 (2012), ruling that state law "does not require that an Alabama municipality have indebtedness in the form of refunding bonds or funding bonds as a condition to eligibility to proceed under Chapter 9." According to the court, "It is clear that the legislature intended to authorize every county, city, town, and municipal authority . . . to file for federal bankruptcy protection."

SOVEREIGN DEBTORS

In NML Capital, Ltd. v. Republic of Argentina, 699 F.3d 246 (2d Cir. 2012), the Second Circuit upheld a lower-court order enjoining the Republic of Argentina from making payments on restructured debt without making comparable payments to bondholders who did not participate in the restructurings in accordance with an "equal treatment" or "pari passu" clause in the bond indenture. The Second Circuit remanded the case below for the purpose of clarifying how the injunction was to operate.

On November 21, 2012, the district court on remand ordered Argentina to pay holdout bondholders approximately $1.33 billion. See NML Capital, Ltd. v. Republic of Argentina, 2012 BL 329784 (S.D.N.Y. Nov. 21, 2012). However, Argentina received a reprieve of its obligation to make the payments on November 28, 2012, when the Second Circuit stayed the ruling until it has an opportunity to hear Argentina's appeal, which has been scheduled for argument on February 27, 2013. The emergency stay quelled investor fears of a default by Argentina on December 15, 2012, when $3.3 billion in debt repayments were due.

On December 4, 2012, the Second Circuit denied an emergency motion by old bondholders to modify the stay by requiring Argentina to post $250 million in security. On December 28, 2012, Argentina asked the Second Circuit to reconsider its pari passu ruling, claiming that the decision violates Argentina's sovereignty. The U.S. government filed an "amicus" brief backing Argentina's request, arguing that the ruling impacts U.S.- Argentina relations, threatens future debt restructurings, and blocks the legal immunity given to a sovereign country.

VENUE

Under 28 U.S.C. § 1408, a bankruptcy case (except a case under chapter 15) may be filed in any federal district in which the debtor's "domicile, residence, principal place of business . . . or principal assets in the United States . . . have been located for the one hundred and eighty days immediately preceding" the filing of the case. The debtor may also file for bankruptcy in the district in which a case is pending concerning any affiliate, general partner, or partnership of the debtor. Consistent with general rules governing the proper venue for litigation in federal courts, a corporation's "domicile" is generally held to be its state of incorporation.

Under 28 U.S.C. § 1412, "[a] district court may transfer a case or proceeding under title 11 to a district court for another district, in the interest of justice or for the convenience of the parties." Most bankruptcy courts have interpreted 28 U.S.C. § 1406 (regarding cure or waiver of venue defects) to require transfer of venue to an appropriate district if the debtor, faced with an objection to venue, cannot establish compliance with the requirements of 28 U.S.C. § 1408.

In In re Houghton Mifflin Harcourt Publishing Co., 474 B.R. 122 (Bankr. S.D.N.Y. 2012), the debtor and 24 of its affiliates filed for chapter 1 1 protection in the Southern District of New York to seek confirmation of a prepackaged chapter 11 plan. According to the debtors, venue was proper in that district under the "affiliate rule" because one debtor had a "residence" in New York City and a second had its "principal asset" there. No creditors objected to the venue selected by the companies. In fact, creditors unanimously approved the debtors' prepackaged plan of reorganization and signed plan support agreements that required the cases to be filed in the Southern District of New York.

The U.S. Trustee objected to the chosen venue. The bankruptcy court was critical of the U.S. Trustee's objection, noting that "a transfer would be more expensive and much less convenient for the Debtors' creditors - especially since we here have a prepack, where the case otherwise would be over in 30 days." However, the court felt constrained by 28 U.S.C. § 1406 to rule on the U.S. Trustee's objection. It ultimately held that: (i) the "residence" basis for venue in 28 U.S.C. § 1408 applies only to natural persons and thus could not apply to the first debtor; and (ii) the second debtor's principal asset was its ownership interest in its subsidiaries, and such property was located outside New York.

Despite its determination that venue in the Southern District of New York was improper, the court realized that "a transfer would be destructive to creditor interests, to the great expense and inconvenience of the parties (especially creditors), and the exact opposite of the interests of justice." It accordingly fashioned a creative solution. The court confirmed the debtors' chapter 11 plan while the U.S. Trustee's objection was still pending and ordered venue of the cases to be transferred to another district after the effective date of the plan.

In In re Patriot Coal Corp., 482 B.R. 718 (Bankr. S.D.N.Y. 2012), the court held that the debtor parent company's incorporation of two subsidiaries in New York shortly before its bankruptcy filing, while technically complying with the "affiliate rule" in 28 U.S.C. § 1408, was inconsistent with the intent of the rule. "Whether one characterizes the creation of venue as exploiting a loophole or as simply not fair," the court wrote, "one thing is clear: It is not the thing which the statute intended." According to the court, although the debtors complied with section 1408, how they complied with the statute must be taken into account when considering the "interest of justice" prong of section 1412. The court directed that venue be transferred to Missouri because the debtors' corporate headquarters and executive offices were located there and because it would offer the most convenience to the greatest number of parties.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.