BUSINESS LAW NEWS, ISSUE 3, 2022

INTRODUCTION

In Spyglass Media Group v. Cohen (In re Weinstein Co. Holdings LLC), the United States Court of Appeals for the Third Circuit ruled that a work-for-hire contract to produce the 2012 film Silver Linings Playbook in exchange for a share of the film’s future receipts was not an executory contract in the Weinstein Company’s (“TWC”) 2018 bankruptcy case.

An executory contract under section 365 of the Bankruptcy Code may only be assumed and assigned to a buyer if all defaults are cured or the debtor provides adequate assurance of prompt cure. Thus, the determination that a contract is executory can make the purchase of assets from a bankruptcy estate more expensive. Whether a contract is executory can mean the difference between a contract counterparty getting paid in full, versus getting paid much less, or nothing, as a general unsecured creditor of a debtor in bankruptcy.

If a contract is determined to be nonexecutory, the rights of the debtor under the contract may be sold to a buyer pursuant to section 363 “free and clear” of the debtor’s past obligations. Accordingly, a debtor may transfer its rights and obligations under the contract, and existing defaults under the contract need not be cured.05 If a contract is not executory, claims for breach or default existing as of the petition date are rendered unsecured claims against the debtor’s estate.

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SUMMARY
In Ly v. Che (In re Ly), 2015 WL 1787575 (9th Cir. Apr. 21, 2015), the U.S. Court of Appeals for the Ninth Circuit affirmed the BAP’s issuance of sanctions against an appellant and its attorney for filing a frivolous appeal, but declined to issue further sanctions because (a) the BAP cases that foreclosed the appellant’s arguments were not binding on the Ninth Circuit, and (b) a non-frivolous argument could be made that the reasoning of those BAP cases should not be adopted by the Ninth Circuit.

To read the full, unpublished decision, click here:  1.usa.gov/1T7Xqn6.

FACTUAL BACKGROUND[1]
In 2006, a forged deed was recorded with the L.A. County’s recorder’s office, purporting to transfer title of certain residential real property from Michelle Che (“Che”) to occupant Alen Ly (“Ly”).  When Che found out about it, she sued Ly and obtained a default judgment declaring the deed void and enjoining Ly from coming within 100 yards of the property.  Ly apparently refused to move out.

Ly filed for bankruptcy in April 2012; in his schedules he claimed to own the property.  A few months later, Che filed a motion for relief from stay to commence eviction proceedings.  Ly opposed the motion on the grounds that Che was not a real party in interest, and lacked standing to seek relief, because Ly had allegedly purchased the property from Che in July 2006.  Ly claimed that he had retained counsel to handle the state court litigation, and was shocked when he later received a 5-day notice to quit.

The bankruptcy court granted Che’s motion for relief from stay, and Ly appealed to the BAP.  Che responded by, among other things, filing a motion asking the BAP to sanction Ly and his counsel for filing a frivolous appeal.  Ly did not file any response to the motion.

In an unpublished decision, the BAP affirmed.  In doing so, the BAP referred to two cases it published in 2011 holding that a party moving for stay relief has a colorable claim sufficient to establish standing to prosecute the motion if it has an ownership interest in the subject property.  See Veal v. Am. Home Mortg. Servicing, Inc. (In re Veal), 450 B.R. 897, 913 (9th Cir. BAP 2011); Edwards v. Wells Fargo Bank, N.A. (In re Edwards), 454 B.R. 100, 105 (9th Cir. BAP 2011).

The BAP also sanctioned Ly and his counsel pursuant to FRBP 8020.  The BAP identified two reasons for its issuance of sanctions.  First,

Second, the BAP found it “particularly troubling” that when Ly’s counsel filed Ly’s original excerpts of the record, he omitted exhibits to declarations filed in support of Che’s motion for relief from stay (including the certified copy of the judgment), though he did include exhibits to his own declaration.  Ly’s counsel “had to be aware that the Judgment was a critical part of the evidentiary record before the bankruptcy court supporting its finding that Che had standing to seek stay relief.”  Ly’s counsel only supplemented the excerpts of the record to include the judgment after the BAP’s motions panel ordered Ly “to supplement the record with a complete copy, ‘including exhibits,’ of the Stay Motion.”

Ly appealed the BAP’s affirmance of the bankruptcy court’s order, and the BAP’s issuance of sanctions, to the Ninth Circuit.  Che responded by filing a motion with the Ninth Circuit requesting additional sanctions against Ly and his counsel.

NINTH CIRCUIT’S RULING AND REASONING
First, the Ninth Circuit easily affirmed the BAP’s affirmance of the bankruptcy court’s order granting relief from stay.

Second, the Ninth Circuit ruled that the BAP did not abuse its discretion in sanctioning Ly and his attorney for filing a frivolous appeal. “Given the case law directly contradicting [Ly’s] position [i.e., Veal and Edwards], the result of Ly’s appeal was obvious and his arguments were ‘wholly without merit.’”

However, applying the exact same standard that the BAP applied when it issued its sanctions, the Ninth Circuit declined to issue further sanctions against Ly and his attorney because “the cases that foreclosed Ly’s arguments before the BAP, [Veal] and [Edwards], are not binding on this court.  Accordingly, because a non-frivolous argument could be made that the reasoning of those cases should not be adopted by this Court, although no such argument was made, we decline to impose sanctions for a frivolous appeal in the exercise of our discretion.”

AUTHOR’S COMMENTARY
Based on the facts described in the BAP’s decision, Che clearly had standing to move for relief from stay and Ly’s appeal was frivolous.  But mixed signals from the Ninth Circuit make this decision notable.  While a circuit court can certainly exercise its own discretion in deciding whether to issue sanctions, how can the further appeal to the circuit court be considered non-frivolous where the circuit court affirms a lower court’s issuance of sanctions for filing a frivolous appeal?

In any event, litigants who intend to challenge a prior BAP ruling before the circuit court should elect to proceed before the district court or should be certain to make a non-frivolous argument that the prior BAP decision should be overruled.  Otherwise, even if a non-frivolous argument could be made that the BAP’s prior ruling should not be adopted by the circuit court, a party and counsel risk sanctions simply because the BAP considers its published rulings binding on subsequent panels.  See Ball v. Payco-Gen. Am. Credits, Inc. (In re Ball), 185 B.R. 595, 597 (9th Cir. BAP 1995) (“[w]e will not overrule our prior rulings unless a Ninth Circuit Court of Appeals decision, Supreme Court decision or subsequent legislation has undermined those rulings.”); Inst. of Imaginal Studies v. Christoff (In re Christoff), 527 B.R. 624, 634 (9th Cir. BAP 2015).

These materials were written by John N. Tedford, IV, of Danning, Gill, Diamond & Kollitz, LLP (jtedford@dgdk.com).  Editorial contributions were provided by Everett L. Green of the Insolvency Law Committee. 

Thank you for your continued support of the Committee.

Best regards,

Insolvency Law Committee

Return to  John N. Tedford, IV 

INTRODUCTION
A creditor with a lien against property subject to a sale under the Bankruptcy Code generally is entitled to bid the value of its claim. This avenue for lenders to recover on their collateral may also be an opportunity for distressed asset investors. Looking for a market advantage, investors may seek to acquire loans and the associated liens with an eye toward foreclosure or the acquisition of the property outright through a section 363 sale. The credit bid is an attractive option to the purchaser who may have acquired the underlying loan rights at a steep discount. However, such a venture will not always be welcome by the trustee or debtor seeking to maximize the recovery from the sale of an estate asset.

THE STATUTE
11 U.S.C. § 363(k) provides as follows:

At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.

This provision warrants some unpacking. While the right to credit bid is an important right to creditors, this right is by no means absolute, as the bankruptcy court may “for cause” deny the right to credit bid.

THRESHOLD ISSUES
As a threshold matter, a party seeking to credit bid must have a valid secured claim. If the secured claim is subject to dispute at the time of the sale under section 363, the bankruptcy court may not allow the creditor to credit bid, or may allow the creditor to credit bid provisionally, requiring the creditor to pay in cash if the claim is reduced or the lien is invalidated.[1]

Another barrier to credit bidding is lien seniority. A junior lienholder may be barred from credit bidding where the collateral is so far underwater that the lien itself has no value.[2]

When such issues are overcome, there are yet other reasons, having more to do with the equities and the economics of the particular sale and case, that may constitute cause to deny the right to credit bid.

RadLAX
There is a line of cases in which the trustee or debtor-in-possession seeks to sell property without credit bidding. The most recent Supreme Court decision on the issue is RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012). The debtors in RadLAX purchased the Radisson Hotel at the Los Angeles International Airport in 2007. The debtors owed the bank $120 million when they filed for chapter 11 protection in 2009. The debtors proposed a chapter 11 plan which contemplated sale of the property, and which would require the bank to bid in cash. The bank objected. Turning to the “cramdown” provisions of section 1129(b), under which a debtor may confirm a plan over creditors’ objections, the Court determined that the denial of the right to credit bid was impermissible under the circumstances. Section 1129(b)(2)(A)(ii) provides:

For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:

(A)With respect to a class of secured claims, the plan provides—…

(ii) for the sale, subject to section 363…(k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph.

The debtors argued that they need not satisfy 1129(b)(2)(A)(ii) because they satisfied 1129(b)(2)(A)(iii), which provides:

    (A)With respect to a class of secured claims, the plan provides—…

(iii)for the realization by such holders of the indubitable equivalent of such claims.

The debtors reasoned that by paying the bank from sale proceeds, the debtors would be giving the bank the “indubitable equivalent” of its secured claim. The Court rejected this argument based on a basic canon of statutory interpretation—“that the specific governs the general.” Since (A)(ii) is specific to sales, it governs. In a footnote, the Court mentioned that that the bankruptcy court had found that there was no “cause” to deny credit bidding under section 363(k).[3]

“CAUSE” TO DENY THE RIGHT TO CREDIT BID
“Cause” to deny the right to credit bid is not defined in the Bankruptcy Code. Besides the circumstances concerning the validity or value of the lien addressed above, Courts have generally found “cause” to exist where denial is “in the interest of any policy advanced by the Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment.”[4] A finding that a party has engaged in misconduct vis-à-vis the estate may be cause to deny the right to credit bid.[5] Beyond such examples, courts have found that the chilling of bidding can constitute cause.[6] The court in Fisker Automotive Holdings denied credit bidding because, under the circumstances, it determined that credit bidding would have made an auction essentially impossible.[7] These issues will be discussed at greater length in a future Inforuptcy blog post. It is sufficient for our purposes to conclude that, notwithstanding the generally accepted importance of the right to credit bid,[8] “cause” can be a fairly broad concept limiting, or eliminating, the right in many cases.

THE “FULL CREDIT BID”
As a final consideration in this overview, it must be noted that the concept of credit bidding is enshrined under nonbankruptcy law.[9] Under nonbankruptcy law, the “full credit bid” (that is an amount equal to the unpaid principal, interest and foreclosure expense) has the effect of extinguishing the creditor’s rights and remedies, including against guarantors and insurers. Thus, it should be exercised with caution.[10]

CONCLUSION
The credit bid in bankruptcy is a potentially powerful tool and valuable asset to creditors and distressed property investors. It must however be approached and exercised with knowledge of the potential pitfalls.

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Return to Zev Shechtman, Partner

SUMMARY:

A Michigan bankruptcy court recently held that the doctrine of sovereign immunity is abrogated by 11 U.S.C. § 106(a)(1) with respect to a bankruptcy trustee’s action to avoid fraudulent transfers against a branch of the state under 11 U.S.C. § 544(b)(1). The court found that the requirement that an “actual creditor” be able to assert a fraudulent transfer action under applicable bankruptcy law did not make the doctrine of sovereign immunity applicable notwithstanding the express language of section 106(a)(1). Kohut v. Wayne Cnty. Treasurer (In re Lewiston), 528 B.R. 387 (Bankr. E.D. Mich. 2015).

FACTS:

The chapter 7 trustee filed a complaint against the county to avoid and recover $307,602.83 in fraudulent transfers pursuant to 11 U.S.C. §§ 544(b)(1) and 550. The individual debtor was a real estate developer. During the six years prior to his bankruptcy filing, the debtor personally made transfers to the county to pay taxes and fees owed by his real estate projects. The debtor had no legal obligation to personally pay the taxes; the debtor’s projects were insolvent when he made the transfers to the county; and the debtor received no benefit in exchange for his payments to the county. The county moved to dismiss the complaint based primarily on the doctrine of sovereign immunity.

The trustee brought the complaint under 11 U.S.C. § 544(b)(1) which allows a trustee to avoid transfers that an unsecured creditor of the debtor could avoid pursuant to applicable nonbankruptcy law. Pursuant to section 544(b)(1), the trustee brought the complaint under the Michigan Uniform Fraudulent Transfer Act (“MUFTA”). The court noted two significant differences between a cause of action brought under 11 U.S.C. § 548 (the Bankruptcy Code’s fraudulent transfer statute) and one brought under MUFTA pursuant to section 544(b)(1): (1) MUFTA allows the avoidance of fraudulent transfers made within six years before the filing of the complaint while section 548 has a shorter two year reach back period; and (2) section 544(b)(1) requires that an actual unsecured creditor could have brought the fraudulent transfer claim under applicable nonbankruptcy law.

In its motion to dismiss, the county contended that an actual unsecured creditor could not bring the MUFTA cause of action under applicable nonbankruptcy law because the doctrine of sovereign immunity bars causes of action against the county. The county argued that it is a political subdivision of the state and thus is immune from suit unless it consents under the 11th Amendment of the United States Constitution and Michigan state law. See Pohutski v. City of Allen Park, 641 N.W.2d 219 (Mich. 2002). The trustee generally did not dispute these claims, but argued that the county’s sovereign immunity was expressly waived under 11 U.S.C. § 106(a)(1), which provides that “[n]otwithstanding an assertion of sovereign immunity, sovereign immunity is abrogated as to a governmental unit to the extent set forth in this section with respect to” section 544, among various other specifically enumerated Bankruptcy Code sections.

The county conceded that section 106(a)(1) abrogates sovereign immunity with respect to section 544 and did not attempt to challenge the holding of the United States Supreme Court in Central Virginia Community College v. Katz, 546 U.S. 356 (2006), which upholds the power of Congress to abrogate states’ sovereign immunity in enacting bankruptcy laws pursuant to the Bankruptcy Clause (Art. I, § 8, cl. 4). Rather, the county’s argument was that since an “actual” creditor under nonbankruptcy law could not bring the cause of action because of sovereign immunity, neither could the trustee by virtue of section 544(b)(1).

REASONING:

The case law on this issue is split. The Seventh Circuit, the only circuit court to address the issue, found in In re Equipment Acquisition Resources, Inc. 742 F.3d 743 (7th Cir. 2014) that an action could not be brought against the I.R.S. under section 544(b)(1) because an actual creditor could not sue the Internal Revenue Service (“I.R.S.”) under the Illinois Uniform Fraudulent Transfer Act under the doctrine of sovereign immunity. Accord Dillworth v. Ginn (In re Ginn-La St. Lucie Ltd.), No. 10-2976-PGH, 2010 WL 8756757 (Bankr. S.D. Fla. Dec. 10, 2010); Pyfer v. Katzman (In re National Pool Construction, Inc.), no. 09-34394, 2015 WL 394507 (Bankr. D.N.J. Jan. 29, 2015).

On the other side, there are cases such as Zazzali v. Swenson (In re DBSI, Inc.), 463 B.R. 709 (Bankr. D. Del. 2012) which concluded, based on a textual analysis of section 106(a)(1), that the express abrogation of sovereign immunity with respect to section 544 was not consistent with the application of sovereign immunity under certain circumstances. Quoting another case, the court rhetorically inquired:

Why would Congress explicitly waive sovereign immunity for all other avoidance actions under the Bankruptcy Code, and include a waiver of sovereign immunity for actions under section 544 knowing that section 544 encompasses state law theories, but then require a separate waiver of sovereign immunity for the necessary state law component in actions under section 544? The argument offered by the United States defies logic.

In re DBSI, 463 B.R. at 717 (quoting Furr v. I.R.S. (In re Pharmacy Distributor Services, Inc., 455 B.R. 817, 821 (Bankr. S.D. Fla. 2011)). Accord VMI Liquidating Trust v. United States (In re Valley Mortgage Inc.), no. 12-01277-SBB, 2013 WL 5314369 (Bankr. D. Colo. Sept. 18, 2013).

Recognizing the split in the statutory interpretation, the Michigan bankruptcy court here concluded in favor of abrogation of sovereign immunity. The court reasoned:

The statute is susceptible to only one interpretation: it simply eliminates sovereign immunity however and whenever it applies “with respect to” the 59 sections of the Bankruptcy Code listed in § 106(a)(1). Section 544 is one of those sections. In this case, the Complaint is brought under § 544. That ends the inquiry. Wayne County cannot raise sovereign immunity as a defense to the Complaint under § 544 because sovereign immunity with respect to § 544 is unequivocally and unambiguously abrogated by § 106(a)(1).

The argument that the “actual creditor” requirement of section 544 cannot be met outside of bankruptcy because of sovereign immunity, the court concluded, did not pass logical muster. Indeed, an actual creditor could prevail, notwithstanding sovereign immunity, because section 106(a)(1) expressly abrogates sovereign immunity with respect to an action brought under section 544. Accordingly, the court denied the county’s motion to dismiss.

AUTHOR’S COMMENT:

The Insolvency Law Committee recently published an e-Bulletin regarding the above cited case of Pyfer v. Katzman (In re National Pool Construction, Inc.), no. 09-34394, 2015 WL 394507 (Bankr. D.N.J. Jan. 29, 2015), which came to the opposite result. As noted in the earlier e-Bulletin, the court in National Pool Construction did not provide a full discussion of case law coming out on the side of abrogation of sovereign immunity. Here, however, the court considered both sides of the argument and came out in favor of abrogation. What we are left with is a significant divide in the statutory interpretation, with one faction interpreting the “actual creditor” requirement in section 544 to come ahead of section 106(a)(1), and the other finding that the abrogation of sovereign immunity set forth in section 106(a)(1) as it applies to section 544 must be understood to apply to the underlying state law.

These materials were prepared by Zev Shechtman (zshechtman@dgdk.com) of Danning Gill Diamond & Kollitz LLP, Los Angeles, California. Editorial contributions were provided by ILC member Doris A. Kaelin, of Gordon & Rees LLP and Peter J. Gurfein (pgurfein@lgbfirm.com) ILC e-Bulletin co-editor-in-chief.

Return to Zev Shechtman, Partner