The bankruptcy legal landscape presents both challenges and opportunities for businesses navigating financial distress. Understanding current bankruptcy trends can help businesses make more informed and strategic decisions.
Corporate Bankruptcy Filings Trending Upwards
Bankruptcy filings continued to trend upwards in 2024. According to statistics released by the Administrative Office of the U.S. Courts, personal and business bankruptcy filings rose 16.2 percent in the twelve-month period ending September 30, 2024, compared with the previous year.
Business filings saw the biggest jump, rising 33.5 percent, from 17,051 to 22,762 in the year ending September 30, 2024. While no industry has been immune, the retail, healthcare, auto, hospitality, and energy sectors have experienced the greatest uptick. The corporate bankruptcy trend is expected to continue in 2025, as businesses face rising inflation, higher labor costs, and elevated interest rates.
Bankruptcy Litigation Insights
Given that disputes often arise within a bankruptcy case, an uptick in bankruptcy litigation is almost certain to follow the increase in filings. Bankruptcy litigation issues that took center stage in 2024 are also likely to continue for the near future. Below are just a few to consider:
Third-Party Releases
Lower courts continue to issue a flurry of decisions interpreting and applying the U.S. Supreme Court's decision in Harrington, United States Trustee, Region 2 v. Purdue Pharma L.P.The case ended the longstanding debate regarding the validity of nonconsensual third-party release provisions. By a vote of 5-4, the Court held that the U.S. Bankruptcy Code does not authorize a release and injunction that, as part of a plan of reorganization under Chapter 11, effectively seek to discharge claims against a nondebtor without the consent of impacted claimants. Issues currently being litigated include what constitutes "consent" for third-party releases and whether the decision impacts the validity of "full satisfaction" third-party releases.
Texas Two-Step
Courts also continue to address the use of a corporate restructuring strategy known as the "Texas Two-Step," in which a solvent parent company spins off current and future tort liabilities into a new company. The shell company tasked with defending and settling the claims then files for Chapter 11 protection.
In In re LTL Mgmt. LLC, the Third Circuit Court of Appeals dismissed a Chapter 11 filing by a Johnson & Johnson subsidiary that relied on a Texas Two-Step corporate restructuring to limit Johnson & Johnson's talc-related liabilities. According to the Third Circuit, LTL Mgmt. LLC's Chapter 11 filing was not made in "good faith" as required under the Bankruptcy Code because the debtor was not in financial distress, and the case did not serve a "valid bankruptcy purpose." In reaching its decision, the appeals court emphasized that the Code does not expressly define the meaning of "good faith" in this context, but the standard adopted by the Third Circuit requires a debtor to demonstrate good faith by showing: (a) "a valid bankruptcy purpose," and (b) that it did not file the petition "merely to obtain a tactical litigation advantage."
Uptier Transactions
"Uptier" transactions — where a borrower teams up with a majority of its financial creditors and amends their existing financing agreements to authorize the issuance of new, super priority debt — were also the subject of several notable decisions. Non-participating minority creditors, which are essentially left with subordinated debt, frequently challenge such transactions.
In In re Serta Simmons Bedding, LLC, the Fifth Circuit Court of Appeals vacated a bankruptcy court order confirming the Chapter 11 plan of Serta Simmons Bedding, LLC to the extent that it included the uptier transaction. According to the appeals court, Serta's uptier transaction did not constitute an open market purchase and therefore violated the pro rata sharing requirements of the underlying credit agreement. In reaching its decision, the Fifth Circuit reasoned that an open market purchase requires parties to purchase the debt on the specific market relevant to the purchased product, such as the secondary market for broadly syndicated loans, in a transaction that was open to participation by various buyers and sellers.
Safe Harbor Provisions
Disputes over the scope of the "safe harbor" under Section 546(e) of the U.S. Bankruptcy Code remain common. The provision prevents avoidance in bankruptcy of certain securities, commodity, or forward-contract payments. Pursuant to Section 546(e) of the Bankruptcy Code, "notwithstanding the substantive avoidance powers set forth in [the Bankruptcy Code], the trustee may not avoid a transfer that is a ... settlement payment ... or ... transfer made by or to (or for the benefit of) a ... financial institution ... in connection with a securities contract."
In In re Boston Generating, LLC, the Second Circuit Court of Appeals held that payments made in connection with a pre-bankruptcy recapitalization transaction qualified under the safe harbor provision. The appeals court found that the tender offer and dividend at issue were both securities transactions, and the debtor and transferee both were "financial institutions," as defined by section 101(22)(A) of the Bankruptcy Code, because they were customers of their agent bank. While the decision is good news for recipients of funds arising out of such transactions, the Second Circuit's broad interpretation of the safe harbor provision with respect to securities transactions will likely be subject to future legal challenges.
Unsecured IP Claims
In In re Mallinckrodt PLC, the Third Circuit Court of Appeals held that, in the absence of any security, a claim asserted by the seller of IP rights for contingent royalties payable under the sale agreement was a prepetition unsecured claim. Accordingly, it was discharged when the bankruptcy court confirmed the purchaser turned debtor's Chapter 11 plan.
As the appeals court explained, "Once the parties agree to a contingent right to payment, the claim exists. And once the claim exists, bankruptcy can reach it." The Third Cstircuit further noted that the seller could have protected itself by structuring the deal differently, such as by licensing the rights to the drug, retaining a security interest in the intellectual property, or establishing a joint venture to keep part ownership.
What's Next?
With courts continuing to face backlogs, businesses are increasingly looking to alternative forums as a means to expedite bankruptcy disputes. Given that ADR also offers flexibility and cost-effective solutions, mediation and arbitration will likely to play a growing role in resolving bankruptcy-related disputes.
With the change in administration, businesses should closely monitor the regulatory landscape. While the Trump Administration hasn't signaled that it plans to make major changes to federal bankruptcy laws, business-friendly deregulation in other areas may help distressed entities, such as by providing access to new capital.
Technological developments also warrant attention in 2025. As the use of digital assets continues to grow, courts are working to establish legal precedents regarding the treatment of cryptocurrency assets in bankruptcy proceedings. Another area to watch is the handling of IP rights in bankruptcy cases, as these intangible assets continue to grow in value and strategic importance. Finally, the role of artificial intelligence in bankruptcy proceedings may grow in 2025. While the use of AI is still in its infancy, it has the potential to streamline bankruptcy administration, including document review, fraud detection, and claims processing.
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.
