z Bankruptcy Litigation Blog : Code Statutory Interpretation

7th Circuit: Bankruptcy Code Doesn't Override the "In Pari Delicto" Defense

Peterson v. McGladry & Pullen, LLP, 2012 WL 1088274 (7th Cir. April 3, 2012) (pdf), is an important new case from the 7th Circuit addressing the ability (or better, inability) of a bankruptcy trustee to overcome the "in pari delicto" defense on policy grounds alone.  In it, Judge Easterbrook--writing for the majority--once again grounds his opinion on the bedrock principle laid down by the US Supreme Court in Butner (1979) that "state law defines the 'property' that enters the bankruptcy estate, unless a provision in the Bankruptcy Code displaces state law."  Id. at *3.  Here are key quotes from the case:

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Treatment of IP Licenses in Bankruptcy: An Updated 2011 PLI Seminar Outline

Last year I spent about 75 hours creating an outline on the treatment of intellectual property licenses in bankruptcy for a PLI seminar, which I published here

PLI asked me back to speak next year at the 2011 Advanced Licensing Agreements seminar in Chicago on April 27-28.  I just updated last year's outline, adding another 8 pages.  Here's the clean version, and here's the redline showing changes from last year's draft.  I'm sure anyone involved with IP issues in bankruptcy will find peace of mind from this outline.

Happy holidays!

© Steve Jakubowski 2010

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3d Circuit Further Explains the Limited Scope of a Bankruptcy Court's Subject Matter Jurisdiction

[1/13/10 Update:  Thanks to Steve Sather from A Texas Bankruptcy Lawyer's Blog for his comment below.  In his post today, he discusses in greater length the opinion of Judge Edith Jones in holding that "related to" jurisdiction exists over a non-debtor dispute if the indemnity right is contractually based, and hence had already "accrued."  Lone Star Fund V (US), LP v. Barclays Bank, PLC, No. 08-11038 (5th Cir. 1/11/10) (pdf).

To further complicate matters, take a look at a recent decision of Judge Laurel Isicoff, who held that regardless of whether the Pacor test was satisfied, the court had "related to" jurisdiction over a third party franchisor's claims against the debtor's principal where the proceeding arose out of same core of facts as one whose outcome could have a Pacor-type effect, and thus the prerequisites for exercise of "supplemental jurisdiction" were satisfied. Century 21 Real Estate, LLC v. Prestige Realty Group of Ohio & Florida, LLC (In re Prestige Realty Group of Ohio & Florida, LLC), 2009 WL 3817297 (Bankr. S.D. Fla. 11/13/2009).  Respectfully, Judge Isicoff's ruling is not the law in the 7th Circuit, however, so be sure to check your local practice first.  See, Banc of America Inv. Servs., Inc. v. Fraiberg (In re Conseco, Inc.), 305 B.R. 281 (Bankr. N.D. Ill. 2004) (bankruptcy court cannot exercise supplemental jurisdiction under § 1367(a) because it is not a district court.and such exercise would amount to "related to related to" jurisdiction).  It's also a position at odds with 3rd Circuit's decision in In re Exide Techs., 544 F.3d 196 (3d Cir. 2008), which expressly rejected the “intertwinement” theory under which otherwise non-core disputes among non-debtors could be treated as core bankruptcy matters based on the extent of their "intertwinement" with core disputes between those parties and the debtor.]

***

As noted in this post last June, it is fair to assume that the U.S. Supreme Court would not permit a bankruptcy court to adjudicate, settle, or enjoin claims against nondebtors that do not affect the debtor’s estate.  In perhaps the final bankruptcy decision of 2009, the Third Circuit rang in the new year with yet another important case--consistent with this general principle-- interpreting the scope of a bankruptcy court's subject matter jurisdiction.  W.R. Grace & Co. v. Chakarian (In re W.R. Grace & Co.), 2009 WL 5151089 (3d Cir. 12/31/09) (pdf).  In it, the Third Circuit both reaffirmed its previous holdings on the limited scope of a bankruptcy court's "related to" jurisdiction and further held that Code section 105(a) does not expand a bankruptcy court's subject matter jurisdiction beyond its statutory boundaries in 28 U.S.C. § 1334(b) (which grants bankruptcy courts "original but not exclusive jurisdiction of all civil proceedings arising under [the Bankruptcy Code] or arising in or related to a case under [the Bankruptcy Code]").

The Third Circuit's seminal opinion in Pacor, Inc. v. Higgins, 743 F.2d 984 (1984), is the most often cited case on the scope of a bankruptcy court's so-called "related to" jurisdiction under 28 U.S.C. § 1334(b). The "Pacor test," which has been nearly universally adopted by federal Courts of Appeal around the country, provides:

[In] determining whether a civil proceeding is related to bankruptcy is whether the outcome of that proceeding could conceivably have any effect on the estate being administered in bankruptcy.  Thus, the proceeding need not necessarily be against the debtor or against the debtor's property.  An action is related to bankruptcy if the outcome could alter the debtor's rights, liabilities, options, or freedom of action (either positively or negatively) and which in any way impacts upon the handling and administration of the bankrupt estate.  Pacor, 743 F.2d 994.

The U.S. Supreme Court, too, looked to Pacor in its first discussion of the scope of a bankruptcy court's "related to" jurisdiction and agreed with Pacor that a bankruptcy court’s "related to" jurisdiction is broad, but "cannot be limitless."  Celotex Corp. v. Edwards, 514 U.S. 300, 308 (1995).

The Third Circuit fine-tuned the Pacor test in In re Federal-Mogul Global, Inc., 300 F.3d 368 (3d Cir. 2002), stating that “[t]he test articulated in Pacor for whether a lawsuit could ‘conceivably’ have an effect on the bankruptcy proceeding inquires whether the allegedly related lawsuit would affect the bankruptcy proceeding without the intervention of yet another lawsuit.”  Id. at 382.  Put another way, there's no "related to" jurisdiction over a third-party claim "if there would need to be another lawsuit before the third-party claim could have any impact on the bankruptcy proceedings."  W.R. Grace, 2009 WL 5151089 at *5 (Op. at 15). 

The Third Circuit further refined the boundaries of the Pacor test in In re Combustion Engineering, Inc., 391 F.3d 190, 225 (3d Cir. 2004), when it held that consideration of additional elements like "unity of interest," "shared production," and "shared insurance" among the debtor and its non-debtor affiliates failed to establish "related to" jurisdiction over third party claims against the non-debtor affiliates "when the third party claim did not directly result in liability for the debtor," but only a potential claim for contribution that "would require the intervention of another lawsuit to affect the bankruptcy estate."  Id. at 231-32.  (Op. at 16-17).

In the recently decided W.R. Grace case, the Third Circuit reaffirmed its holdings in Pacor, Federal-Mogul, and Combustion Engineering, and held that an injunction granted in 2001 (shortly after Grace filed for bankruptcy) against  further prosecution of a lawsuit against Grace for injuries caused by exposure to asbestos at a Montana mine over a 37 year period would not be extended to the State of Montana, who had also been sued by the same plaintiffs for negligence in failing to warn them of the asbestos risks at the mine.  The Montana Supreme Court held that the State of Montana in fact owed the plaintiffs a duty of disclosure of potentially adverse health risks, and so remanded the case back to the trial court for a "determination by the fact-finder of whether the State breached its duty to the [plaintiffs], and if so, whether such breach caused the damages claimed by them."  (Op. at 7).  Grace subsequently moved in the Bankruptcy Court to expand the 2001 injunction to include the plaintiffs' now remanded actions against the State of Montana.  The bankruptcy court refused to so extend the injunction, and the Third Circuit affirmed, holding:

In short, our recently reaffirmed precedent dictates that a bankruptcy court lacks subject matter jurisdiction over a third-party action if the only way in which that third-party action could have an impact on the debtor's estate is through the intervention of yet another lawsuit. Here, we are presented with state court actions that have only the potential to give rise to a separate lawsuit seeking indemnification from the debtor. Accordingly, we must affirm the Bankruptcy and District Courts' conclusion that subject matter jurisdiction does not exist for the purpose of expanding the § 105(a) injunction to preclude the Montana Actions.  (Op. at 18).

Significantly, the Third Circuit also rejected an alternative ground for expansion of the bankruptcy court's subject matter jurisdiction on the basis that "a bankruptcy court has subject-matter jurisdiction to adjudicate a motion in an adversary proceeding initiated by a debtor in its own bankruptcy case, regardless of the subject matter of that motion."  (Op. at 21).  Citing Celotex, the Third Circuit flatly rejected this opportunity to expand upon the bankruptcy court's subject-matter jurisdiction, stating:

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Treatment of IP Licenses in Bankruptcy: Advance Preview of My PLI Seminar Outline

The best thing about tight deadlines is the moment they finally come to an end.  My latest race against time was to complete this 50 page outline (including appendices) for a Practicing Law Institute (PLI) presentation, entitled Treatment of IP Licenses in Bankruptcy, that I'm delivering next April 27 in Chicago as part of the Advanced Licensing Agreements 2010 seminar series.  Here's my introduction to it:

Recent studies report a veritable explosion of intellectual property assets in the past quarter century, with intangible book value as a percentage of market capitalization for the S&P 500 increasing from 1.6% in 1975 to 15.5% in 2005, intangible book value as a percentage of total book value increasing from 1.9% in 1975 to 43.2% in 2005, and intangible market value as a percentage of total market value increasing from 16.8% in 1975 to 79.7% in 2005. Former Fed Chairman, Alan Greenspan, summed up this trend in a speech in 2004 (when his word was still gospel), saying:

In recent decades, the fraction of total output of [the US] economy that is essentially conceptual rather than physical has been rising. The trend has, of necessity, shifted the emphasis in asset valuation from physical property to intellectual property and to the legal rights inherent in intellectual property.

With intellectual property comprising a sizable chunk of reported intangible value, and with vast segments of the world and US economy teetering on the brink of balance sheet or equitable insolvency, it is imperative that IP lawyers understand how bankruptcy law interfaces with intellectual property law for each of the varied types of IP assets and agreements. 

This outline provides an overview of key bankruptcy terms of art, like “intellectual property” and “executory contracts.” It then looks at the rights of the debtor/trustee and nondebtor counterparties to IP licenses; first from the perspective of the debtor/trustee as IP licensee, and second, from the perspective of the debtor/trustee as IP licensor. It concludes with a review of various drafting and other strategic considerations that will assist both in upfront structuring of IP licensing transactions and in addressing the rights of the counterparties as the flames of bankruptcy torch the parties’ original understandings and intentions. Appendices at the back provide a handy “issue spotting checklist” and a select bibliography of some of my favorite scholarly works addressing these issues in greater depth.

Before the internet and explosion of online materials on every subject under the sun, there was PLI--a trusted and much appreciated resource to quickly learn about important topics.  It's a real privilege to have the opportunity to participate in PLI's Advanced Licensing series, and thanks especially to my fellow Union College grad, Ira Levy of Goodwin Proctor, co-chair of the seminar series for inviting me to participate in this event.

My next two holiday posts will be completely off topic, but certainly appropriate for this time of year when most people's  thoughts are fixated, one way or another, on lights; simple reminders of Divine miracles, both great and small, and of all we have to be thankful for.

[The inset picture, of course, is Salvadore Dali's 1931 masterpiece, only 10 x 13 inches in size, entitled "The Persistence of Memory," which came to mind from my latest race against time.  Apparently, Dali--only 27--conceived it while suffering from a headache and a bout of "painter's block" after focusing on some Camembert cheese that he had just eaten.  "The gooey softness of the cheese, the intensifying headache and Dalí’s general mindset all fused, and he came up with the concept of 'soft watches, one of them hanging lamentably.'"  Go figure!]

© Steve Jakubowski 2009

 

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Don't Flub "Stub" Rent: Some Thoughts on Code Section 365(d)(3) from Yitzhak Greenberg

One of blogging's many benefits is in meeting people I would not have otherwise met.  Coming off an extended personal--and blogging--vacation, and with the three-week fall cycle in the Jewish Holidays fast approaching (not to mention my appeal brief in GM due next Wednesday and a chunk of other work), I'm thankful that one of the people I've recently met--Yitzhak Greenberg--has offered to author a guest post for the blog.  Yitzhak is associated with the Law Offices of Gabriel Del Virginia in New York City.  His practice is focused on bankruptcy, including the representation of landlords and tenants in bankruptcy.  He previously worked for a prominent New York City bankruptcy boutique and clerked after law school for Bankruptcy Judge Arthur J. Gonzalez, of Chrysler, Enron, and Worldcom fame.  He was selected by Fordham University School of Law, his alma mater, as a Centennial Fellow, where his responsibilities included assisting in the drafting of The Final Report to the Chief Judge of the State of New York: The Commission to Promote Confidence in Judicial Elections (a topic of considerable interest to Retired Justice Sandra Day O'Connor).  He also just authored the lead article for this month's The Bankruptcy Strategist, File for Chapter 11, Get the First Month’s Rent Free?

If anyone knows anything about "stub" rent, it's Yitzhak, and I thank him for graciously providing us with his thoughtful analysis of this thorny issue of law in this post, which he entitles: 

In re Sportsman's: The Death Knell for Stub Rent?

 
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Judge Markell's Bombshell BAP Ruling That a Winning Credit Bid in a Bankruptcy 363 Sale Doesn't Strip Off Junior Liens Confirms Ominous Predictions That the End of Bankruptcy Is Near!

At the end of last May, Chicago's ten bankruptcy judges gathered at a day-long, TMA-sponsored event and shared their candid, sometimes off-the-cuff, non-binding views on various hot bankruptcy topics.  One of the liveliest panel discussions focused on various issues arising in bankruptcy 363 sales.  In it, former Bankruptcy—now District Court—Judge David H. Coar asked whether any of the bankruptcy judges on the panel (or in the room) would refuse to recognize as the high bidder in a 363 sale a secured creditor who credit bid the full amount of its secured claim.  Everyone in attendance agreed, without fanfare, that if the credit bid reflected the highest bid for the assets, the secured creditor would be declared the winning bidder, even if the creditor was undersecured. 

Judge Coar didn't ask whether the winning credit bidder would, just like any winning cash bidder, take the assets free and clear of all junior liens, claims, and encumbrances, but all in attendance likely would have conceded that point too.  In the end, however, Chief Judge Carol Doyle emphatically cautioned, don't take anything for granted because Code Section 363 is a statutory provision, and it's VERY important to review the statute itself in every case, because a bankruptcy judge's job is to interpret and enforce the statute, not the will of the parties.

When it comes to statutory construction in bankruptcy, as noted in this post, Nevada's Judge Bruce Markell—probably the only judge in US history to have Wittgenstein's entire collected writings on a shelf in his chambers—is one of the best.  So when Judge Markell says that Section 363 doesn't say what everyone thinks it says, now that's news!  Surprisingly though, until today, nothing has yet been publicly reported on Judge Markell's decision (issued late May and released for publication last month), though rumor has it that Arizona's Bankruptcy Judge Randolph Haines, himself no philosophical slouch (having a Yale Ph.D in philosophy), is planning a spirited counter-assault on Judge Markell's reasoning in an upcoming Norton's Bankruptcy Law Advisor release.

So what is it that Judge Markell has said that has judicial colleagues calling him "just plain nuts," that has bankruptcy lawyers consulting Nostradamus seeking confirmation of BairdRasmussen's prediction of the End of Bankruptcy, and that has title companies refusing to insure cases of lien stripping in bankruptcy asset sales?  It's found not in his 1992 scholarly article, The Case Against Breakup Fees in Bankruptcy, but in his judicial opinion in Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC)2008 WL 2840659 (9th Cir. BAP 7/18/08) (pdf), where—joined by the Eastern District of Washington's Chief Bankruptcy Judge Frank Kurtz and Idaho's Chief Bankruptcy Judge Jim D. Pappas, themselves judicial heavyweights in their own right—he wrote as follows:

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Houston's Chief Judge Wesley Steen Refuses to Let Unclaimed Funds Escheat to the Cheats

Houston draws many visitors looking for the hottest and spiciest foods in Texas.  A recent Houston tradition is the "Houston Hot Sauce Festival," which last September for its 8th annual fest drew over 40 competitors statewide.  So who's got the hottest sauce in Texas?  The festival's "2006 People's Choice Award" for the festival's hottest sauce went to the sauce aptly-named "Stupid Hot aka Unbearable."  Sadly, the planners report, "due to a combination of personal tragedy and the general economy, it is not feasible to put on the festival this year."  To the right is last year's official festival t-shirt, an eerie premonition of this year's salmonella-laced deadliest batch.

Houston also is home to one of the hottest bankruptcy districts, whose judges include Judge Marvin Isgur, whose opinions have stirred much controversy on several fronts, and Chief Judge Wesley Steen, who last year completed his term as the first sitting judge to serve as President of the American Bankruptcy Institute.  Much personal gratitude is due Judge Steen for his recommendation of this blog as a resource to incoming judicial clerks, and for the establishment of the ABI Bankruptcy Blog Exchange under his watch, which includes this blog at the top of the list.

As often observed on this blog, Houston's Judge Isgur has laid enough of his own special hot sauce to send debtors, creditors, and lawyers alike rushing for the exit.  Early on, I pinned the classic "Don't Mess with Texaslabel on him for his pathbreaking decision tossing poor Mother Hubbard from her cupboard (though he later reversed himself on other grounds).  Here, he cited to Abe Lincoln's stirring 278-word Gettysburg address to find meaning in 278 words of statutory gibberish.  And here (at p.94, In re Porcheddu, 338 B.R. 729), his extreme hot sauce cost a prominent Texas firm $65,000 for trying to pull the wool over his keen eyes.  Finally, early last year, at a luncheon sponsored by the Houston Association of Debtors Attorneys, Judge Isgur served up some more hot sauce after a credit counseling firm's CEO spouted off about how his firm never hires bankrupts, thus prompting Judge Isgur to launch this investigation into that firm's hiring practices and whether they violated the anti-discrimination provisions of Bankruptcy Code section 525(a).  After laying the hot sauce on thick at this status conference, the CEO finally conceded in these sworn affidavits he was effectively "out to lunch" (which he technically was) when it came to his having real knowledge of the firm's hiring practices (and that, moveover, he wasn't trying to be cute in earlier affidavits to avoid possible sanction).

Judge Steen, for his part, also has his own fiery sauce for lawyers, as reported last year by the WSJ Law Blog's founder, Peter Lattman.  And, of course, who can forget the fiery rebuke of Countrywide and its lawyers delivered by another Houston Bankruptcy Judge, Jeff Bohm, for "negligent bungling" that came within a hair's breadth of "full-blown bad faith."  Finally, let's not forget Houston Bankruptcy Judge Letitia Clark's flaming sauce served in issuing a TRO that enjoined the Russian government's planned auction of Yukos (as reported at length in these series of articles by Houston's Clear Thinker, Tom Kirkendall).  Given recent events in Georgia, she's looking braver and braver by the minute.

So, in the end, just as Houston's Hot Sauce Festival's promoters warn that great sauces may be obscured by ordinary labels, don't let the calm and friendly demeanors of Houston's bankrutpcy judges fool you.  One dose of their own respective blends and you'll feel about as "sharp as a mashed potato," as they say in Texas.

All this is a long-winded late Friday afternoon introduction to the real point of this post, which is Judge Steen's latest decision in In re Premiere Holdings of Texas LP, 2008 WL 2963041 (Bankr. S.D. Tex. 7/28/08) (pdf).  This long running case began shortly after 9/11 and was one of the first sub-prime mortgage debacles, eventually landing the founders in hot water, according to the criminal complaint described here by Tom Kirkendall.  Coincidentally, one of the founders, David Lapin, just pled guilty to criminal charges this past Monday, and the trial of his two other partners is set for later this month (looks like the dominant strategy ruled this prisoner's dilemma).

Meanwhile, Premiere's reorganization plan, confirmed on June 18, 2002, has run its course, and the liquidating trustee made its final distribution to creditors on 4/14/08.  Of the millions distributed, $25,969 in checks remained unclaimed.  Because the plan didn't economically provide for disposition of these unclaimed funds, the liquidating trustee filed a motion to deposit the funds into the Court's registry.  Despite the lack of response or opposition, Judge Steen found himself in a quandary since "deposit of unclaimed funds into the registry of the court is only available under Bankruptcy Code § 347(a) and only for unclaimed funds in chapters 7, 12, and 13."  Conversely, unclaimed funds in a chapter 11, he noted, is governed by Bankruptcy Code § 347(b), which requires that the funds revert to the debtor or to the entity acquiring the assets of the debtor under a plan.

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Delaware's Judge Kevin Gross Rules That, Absent Adequate Protection, Whitehall's Asset Sale May Not Include Consigned Jewels

With classic reorganizations a relic of the past, and retail bankruptcies and distress sales way up, the question of what assets may be sold in a retailer's 363 auction of its primary business assets early in the case is of paramount importance.  One of Delaware's newest Bankruptcy Judges, Kevin P. Gross, addressed this issue last week in the Whitehall Jewelers' bankruptcy case, one day before the bid deadline and ten days before the scheduled August 8th auction.  In re Whitehall Jewelers Holdings, Inc., 2008 WL 2951974 (Bankr. D. Del. 7/28/08) (pdf).  The Deal's Jamie Mason provided this background to the auction:

A Delaware judge has approved the bidding procedures for bankrupt jewelry retailer Whitehall Jewelers Holdings Inc.'s going-out-of-business sales at all of its stores but not the stalking-horse bidder's breakup fee. Since the breakup fee was denied, the group has reserved the right not to participate in the auction, so it's unclear if there will be a stalking-horse bidder for the sale. The stalking-horse bidders had agreed to pay Whitehall, which sells diamonds, gold, precious and semiprecious jewelry and watches, 55.5% of the value of the inventory if it's between $169 million and $177 million. However, if the inventory is worth between $138 million and $145 million, Whitehall will receive 53.5% of the value. This means that Whitehall could receive between $73.8 million and $98.2 million, depending on what its inventory is worth.

With much riding on the value of the inventory, Judge Gross was asked to determine whether it is permissible under Code section 363(f)(4) to sell approximately $63 million of consigned goods in inventory from Whitehall's 373 retail stores in a 363 sale?  The consigned goods weren't segregated at the stores, and the vendors themselves split into two general groups: 

  • Those who failed to file financing statements and those who filed improperly or who failed to comply with UCC Article 9, including those who did not refile when Debtors changed their name (too conveniently so, charged these consignment vendors) from "Whitehall Jewellers" to "Whitehall Jewelers"; and
  • Those whose consignments are governed by UCC Article 2 and therefore are subject to the claims of Debtors' creditors.

Section 363(f)(4) was implicated because the Debtors argued that the consignment vendors' interests in the consigned goods is in bona fide dispute within the meaning of Section 363(f)(4), which permits assets sales free and clear of any third party interest in the property only if such interest "is in bona fide dispute." 

After reviewing various cases within and outside the district, Judge Gross concluded that no sale of the consigned inventory was permitted under Code section 363(f)(4) "without first demonstrating to this Court that the consigned goods are property of the estate." Judge Gross, however, would only resolve that issue by way of a full-blown adversary proceeding and not through a contested sale motion under Section 363. While recognizing the burden on Whitehall from having to initiate over 120 adversary proceedings (i.e, complaints) in the short time available before the sale, Judge Gross concluded that he had no choice in the matter, stating:

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Nemo Filleted: Judge Scheindlin Rules that Good Faith Purchasers of Claims in Bankruptcy Need No Longer Choke on the Personal Disabilities of the Claims Transferor

Last year, then "Junior Scholar" -- and now Associate Professor of Law at Georgetown -- Adam Levitin (who is also a long-time reader of this blog!) wrote an excellent piece entitled Finding Nemo: Rediscovering the Virtues of Negotiability in the Wake of Enron, 2007 Colum. Bus. L. Rev. 83 (WL) / (pdf).  In it, he strongly criticized a decision by Bankruptcy Judge Arthur Gonzalez denying a good faith bankruptcy claim purchaser's motion to dismiss the Enron estate's cause of action for equitable subordination based not on the purchaser's own misconduct, but on the conduct of previous owners of the claims purchased, regardless of whether the conduct related to the claims themselves.  Enron Corp. v. Springfield Assocs., L.L.C. (In re Enron), 2005 WL 3873893 (Bankr. S.D.N.Y.  11/28/05) (pdf).  Professor Levitin sums up his critique of Judge Gonzalez's ruling as follows (at pp. 90-91):

The problems in Enron speak to a fundamental commercial law question about choice of property transfer rules.  Enron was based on the commercial law principle of nemo dat quod non habet -- you can only transfer what you have.  Nemo dat means that defenses travel with property transfers, so if bankruptcy claims would be subject to equitable subordination in the hands of a transferor, they should remain so in the hands of a transferee.

Nemo dat is the default rule for property transfers, but there is a competing commercial law paradigm: negotiability [as in Articles 2, 3, 7, and 8 of the UCC], and the law of real estate mortgages and titles.  The essential characteristic of negotiability is that only limited defenses travel with property, and thus a transferee can receive more than the transferor had--a property right free of certain defenses against its enforcement.  This means that there is some level of negotiability in any area of law with a good faith purchaser defense.... 

Historically, the law has differentiated between whether it adopts a nemo dat regime or a negotiability regime based on whether transactions are commercial or consumer....  [T]his article argues in favor of applying a negotiability regime to bankruptcy claims trading and proposes a general reconsideration of the rules governing the defenses that travel with a property transfer in commercial contexts.

Last January, District Court Judge Shira A. Scheindlin (herself no stranger to high-stakes bankruptcy controversies) granted the disheartened claims purchasers' request for leave to file an interlocutory appeal of Judge Gonzalez's ruling.  She also concurrently granted the request filed in connection with an analogous interlocutory ruling by Judge Gonzalez in Enron Corp. v. Avenue Special Situations Fund II, LP (In re Enron), 340 B.R. 180 (Bankr. S.D.N.Y. 2006) (pdf), in which he disallowed under Code section 502(d) the claim of an entity that purchased its claim from a party who had received a potentially avoidable prepetition transfer.  Judge Scheindlin granted these interlocutory appeals, she said, so that she could consider the following question that "although fairly simply stated, is complex and of first impression in this Circuit, and will have serious ramifications well beyond the parties involved in this particular appeal":

Whether equitable subordination under 510(c) and disallowance under 502(d) can be applied, as a matter of law, to claims held by a transferee to the same extent they would be applied to the claims if they were still held by the transferor based on alleged acts or omissions on the part of the transferor.

Last week, Judge Scheindlin was again the toast of distressed debt industry based on her lengthy decision vacating Judge Gonzalez's decisions.  See Springfield Assocs., L.L.C. v. Enron Corp. (In re Enron), 2007 WL 2446498 (S.D.N.Y. 8/27/07) (pdf).  Though Judge Scheindlin never cites to Professor Levitin's article, she does note -- as does Professor Levitin -- that the central distinction to be made in analyzing the question presented is whether the "well-established doctrine of nemo dat qui non habet" applies.  (Op. at 20-22.) 

To Judge Scheindlin, if the claims are being asserted by good faith purchasers of bankruptcy debt, then the doctrine doesn't apply and the claims cannot be equitably subordinated under Code section 510(c) or disallowed (pending receipt of the avoidable transfer) under Code section 502(d).  Conversely, Judge Scheindlin ruled, if the transferee obtained the claim by way of "assignment," then the nemo dat doctrine applies, the "personal disabilities" of the claimant "travel with the claim," and the assignee's claim is subject to possible subordination and disallowance.  (Op. at 29-44.)

Notably, Judge Scheindlin emphasizes, her decision is not based on policy concerns, and in particular the impact that an affirmance would surely have on depressing values in an already depressed market for distressed debt.  See, e.g., Levitin Article at 161-164 ("Developments in the Refco bankruptcy provide an early look at ... how seriously Enron has affected the claims trading market....  As soon as rumors surfaced of BAWAG's alleged misdeeds, all claims that had ever passed through BAWAG's hands became radioactive before the other Refco creditors filed suit against BAWAG.  No one would purchase them for any price because of the fear of subordination or disallowance.")  Still, she seemed relieved to be able to note not only that "[t]he unnecessary breadth of the Bankruptcy Court's decisions threatened to wreak havoc on the markets for distressed debt," but also that, with this decision, "[t]hat result has now been avoided."  (Op. at 52.)

What then was the basis for Judge Scheindlin's reversal? 

© Steve Jakubowski 2007

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UAL Bankruptcy Court Looks to Context of Specific Code Chapter in Refusing to Exercise Jurisdiction Over Question of Whether Plan Distributions on Union Employee Claims are Taxable as "Wages"

UAL's proposed plan of reorganization provides for a modicum of distributions on the plan effective date of UAL's plan to unionized employees, as required by the terms of revised collective bargaining agreements. UAL, relying upon Bankruptcy Code section 505(a) (which allows the bankruptcy court to "determine the amount or legality of any tax"), sought a declaratory ruling from the bankruptcy court that distributions to employees under the plan cannot be taxed by the IRS as "wages." This issue is quite significant to UAL because a favorable ruling would save UAL tens of millions of dollars in federal withholding taxes and the like that would have to be paid were the distributions to be characterized as "wages" for federal tax purposes.

The UAL bankruptcy court, however, refused to even reach the merits because it concluded (opinion available here) that it lacked jurisdiction to decide the tax effects of a Chapter 11 plan before it has been confirmed.

In so doing, the Court noted the paucity of cases and consensus on "when a tax issue must arise in order to be subject to adjudication" as compared with "whose tax issues may be adjudicated under looked at the language of Code § 505(a)." The Court stated:

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