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Recent & Upcoming SCOTUS Cases in Bankruptcy Moller/Foltz American Bankruptcy Inn of Court Presented on January 29, 2019

U.S. Bank N.A. v. Village at Lakeridge, LLC Issue: What standard of review applies to a bankruptcy court’s determination that a person is a “non-statutory insider” (i.e., an insider not enumerated in the Bankruptcy Code’s non-exclusive definition of “insider” in § 101(31))? Holding: While articulation of legal standard is reviewed de novo, application of standard to facts is reviewed for clear error.

U.S. Bank N.A. v. Village at Lakeridge, LLC Facts: Lakeridge was wholly owned by MBP . It owed U.S. Bank $10 million and MBP about $3 million when it filed for Chapter 11. Plan put debts in separate classes and impaired both. U.S. Bank voted no on plan. Because MBP was an insider, its vote could not be the acceptance by an impaired class necessary to confirm the plan under § 1129(a)(10). MBP thus tried to transfer its claim to a non-insider. Kathleen Bartlett, a member of MBP’s board and an officer of Lakeridge, approached Robert Rabkin , a boyfriend, and offered to sell him MBP’s $3 million claim for $5,000. He agreed and accepted the plan. U.S. Bank objected, arguing that Rabkin was a non-statutory insider whose acceptance should not count, because he had a romantic relationship with Bartlett and the transaction was not at arm’s length. Bankruptcy court held that Rabkin was not a non-statutory insider, finding that he purchased the MBP claim as a “speculative investment,” and he had separate home and finances from Bartlett. Ninth Circuit affirmed, holding that creditor is a non-statutory insider if (1) the closeness of its relationship with the debtor is comparable to that of the enumerated insider classifications in the Code, and (2) the relevant transaction was not negotiated at arm’s length. It concluded that bankruptcy court had made a determination that transaction was at arm’s length, which must be reviewed for clear error and could not be reversed under that standard. Supreme Court granted cert only on the standard of review, refusing to review the Ninth Circuit’s legal test for non-statutory insider status.

U.S. Bank N.A. v. Village at Lakeridge, LLC Opinion of the Court: Legal test for non-statutory insider status is pure question of law reviewed de novo; and historical findings of fact are reviewed for clear error. But what about ultimate question whether facts as found satisfy legal test? That is a mixed question of law and fact. Standard of review thus depends on whether law or fact predominates. “Mixed questions are not all alike.” Here, mixed question was: “Given all the basic facts found, was Rabkin’s purchase of MBP’s claim conducted as if the two were strangers to each other?” “That is about as factual sounding as any mixed question gets.” The bankruptcy court is in a better position to resolve it, so it is reviewed for clear error.

U.S. Bank N.A. v. Village at Lakeridge, LLC Justice Sotomayor’s concurrence: If Ninth Circuit’s legal test for non-statutory insiders was wrong, standard of review could change. Ninth Circuit’s test may not be right: It’s not clear why one would have to show both that a creditor’s relationship with the debtor was comparable to an enumerated insider and that the transaction was not at arm’s length. Section 101(31) has no “not at arm’s length” requirement for enumerated insiders (like an officer’s relative), so why have that requirement for unenumerated insiders (like an officer’s boyfriend)? Concept of “insider” rests on notion that certain people are so closely connected with debtor that no business between them can be at arm’s length. Two other possible standards/tests: Does creditor share sufficient characteristics with enumerated insiders? In light of all the facts and circumstances, including whether transaction was at arm’s length, should this creditor be deemed a non-statutory insider? Either of these tests might have yielded a different result here, under either a de novo or clear error standard of review.

QuestionsWhat role should the “arms-length” inquiry play in the determination of non-statutory insider status? If a statutorily enumerated “insider” does not cease being an insider just because the court finds the transaction at issue was conducted at arm’s length, then why should a finding that a transaction was conducted at arm’s length, without more, foreclose a finding that a person or entity is a non-statutory insider? Should statutory and non-statutory insiders be treated differently, regardless of how close a person’s relationship with the debtor is or whether he is otherwise comparable to a statutorily enumerated insider? (e.g. arm’s length transaction with live-in boyfriend passes the test; same transaction with a spouse would not).

Merit Management Group v. FTI Consulting§546(e): Notwithstanding sections 544, . . . 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer that is a margin payment, as defined in section 101, 741, or 761 of this title, or settlement payment, as defined in section 101 or 741 of this title, made by or to (or for the benefit of) a . . . stockbroker, financial institution, financial participant, or securities clearing agency, or that is a transfer made by or to (or for the benefit of) a . . . stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract, as defined in section 741(7), . . that is made before the commencement of the case, except under section 548(a)(1)(A) of this title.

Merit Management Group v. FTI ConsultingIssue:Does Section 546(e) insulate a payment by a debtor to a holder of securities issued by the debtor from a constructive fraudulent transfer action simply because a financial institution acted as a conduit between the debtor and the securities holder? Holding: No. Section 546(e) does not insulate an otherwise avoidable transfer from avoidance simply because a financial institution acted as an intermediary between the debtor and a holder of securities issued by the debtor. The relevant transfer to examine is the transfer that the trustee is seeking to avoid, i.e. the overarching end-to-end transfer, not each one of the transfer’s component parts.

Merit Management Group v. FTI ConsultingFacts:Valley View Downs, LP ("Valley View "), owned a horse racetrack in Pennsylvania and was competing with another horse racetrack Bedford Downs (" Bedford "), for the last available harness-racing license in Pennsylvania. Valley View later acquired Bedford through an LBO pursuant to which the shareholders of Bedford received $55 million for their shares. Bedford's stock was not publicly traded and was privately held. Valley View borrowed the money for the LBO from a bank group. Citizens Bank of Pennsylvania acted as the escrow agent through which the exchange of the Bedford shares for the $55 million took place.

Merit Management Group v. FTI ConsultingFacts (con’t):Shortly following the LBO, Valley View filed for chapter 11. The bankruptcy court confirmed a chapter 11 plan that appointed FTI Consulting, Inc. (" FTI ") as the Trustee of a litigation trust. FTI initiated a constructive fraudulent conveyance action against Merit Management Group (" Merit "), a shareholder that held 30% of Bedford's stock, and a recipient of approximately $16.5 million through the LBO. Merit, however, argued that Section 546(e) shielded the payment it received because the payment was “made by or to (or for the benefit of) a . . . financial institution”—i.e., a bank acted as a conduit between the debtor and Merit. Merit prevailed at the lower court level but the Seventh Circuit reversed and held in favor of FTI.

Merit Management Group v. FTI ConsultingFacts (Con’t ): 7 th Cir. holds in favor of FTI reasoning that: ( i ) the language of Section 546(e) was ambiguous. The legislative intent of Congress in enacting Section 546(e), was aimed at protecting transfers that are made to financial intermediaries in securities transfer system that are "debtors or actual recipient[s] of a transfer, rather than simply . . . conduit[s] for funds.”; and (ii) The Court’s ruling would not create a ripple effect of insolvencies through the financial system, which is the aim of Section 546(e). Neither Valley View nor Merit were not parties in the security industry but were simply corporations that exchanged money for privately held stock. Merit Management then filed a writ of certiorari to SCOTUS.

Merit Management Group v. FTI ConsultingAnalysisCongress added the language “or for the benefit of” to Section 546(e) so that it “matched the scope” of the language contained in the trustee’s avoidance powers (i.e. Sections 547 and 548(a)(1)), not to insulate parties like Merit, which is not a financial institution, from avoidance actions. The language of Section 546(e) makes clear that it “applies to the overarching transfer that the trustee seeks to avoid, not any component part of the transfer.” The relevant transfer for purposes of Section 546(e) “is the same transfer that the trustee seeks to avoid pursuant to one of its avoiding powers.”

Merit Management Group v. FTI ConsultingOpen issues:Does Section 546(e) apply when publicly traded securities are involved (which generally involve securities clearing agencies and brokerage accounts or custodial accounts)? Merit involved only privately held shares of stock. Would a party’s status as a “customer” of a “financial institution” affect the application of Section 546(e). The definition of “financial institution” refers not only to a bank acting for its own account, but also to the bank’s “customer” when the bank is acting as an agent or custodian for a customer in connection with a securities contract. Merit did not raise this argument. Does Section 546(e) preempt State Law Fraudulent Transfer Actions (SLFTA’s)—i.e., the issue that arose in Tribune ?

In re Tribune Co. Tribune was a large media company that was sold through an LBO. About a year and a half following the LBO, Tribune filed for chapter 11. A large group of individual creditors filed State Law Fraudulent Transfer Actions (“SLFTA’s”) against various shareholder-defendants that redeemed their shares through the LBO. The total amount sought in these various SLFTA’s was approximately $8 billion. The various actions were consolidated in SDNY. Some of these defendants were entities that may qualify as “financial institutions”, as a broker or other protected party under Section 546(e). The Second Circuit held that Section 546(e) impliedly preempts SLFTA’s based on constructive fraud. The individual creditors later filed a petition for certioriari to SCOTUS. SCOTUS, however, did not grant or deny certiorari in Tribune . Instead, following its ruling in Merit, SCOTUS issued a statement urging the 2 nd Circuit to “recall its mandate.” This leaves the issue of whether Section 546(e) preempts SLFTA’s unresolved. Could an individual creditor bring an SLFTA against a “financial institution” or other protected entity that did not act as a conduit but held securities as an investor (i.e. proprietary trading)?

Lamar, Archer & Cofrin, LLP v. Appling § 523. Exceptions to discharge. A discharge … does not discharge an individual debtor from any debt— *** for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by— (A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition ; [or] (B) use of a statement in writing— ( i ) that is materially false; (ii) respecting the debtor’s or an insider’s financial condition ; (iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and (iv) that the debtor caused to be made or published with intent to deceive[.]

Lamar, Archer & Cofrin, LLP v. Appling Issue: Is a statement about a single asset a “statement respecting the debtor’s financial condition” under § 523(a)(2)? Holding: Yes.

Lamar, Archer & Cofrin, LLP v. Appling Facts: Debtor Appling hired Lamar, a law firm, to represent him in litigation. Appling fell behind on bills until he owed $60,000. Lamar threatened to withdraw if not paid. Appling told Lamar orally that he was expecting a tax refund of “approximately $100,000,” which would cover what he owed. Lamar relied on this statement and continued to represent Appling. In fact, Appling received a refund of only about $60,000, none of which he paid to Lamar. Several years later, after no payment, Lamar obtains a judgment against Appling in state court for about $100,000. Appling files for Chapter 7 bankruptcy. Lamar brings adversary proceeding arguing debt is non-dischargeable as debt arising from “false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s … financial condition.” Appling argues debt is dischargeable because his misrepresentation was a statement respecting his financial condition and thus, under § 523(a)(2), had to be in writing to give rise to a non-dischargeable debt.

Lamar, Archer & Cofrin, LLP v. Appling Analysis: Parties agree on meaning of “statement” and “financial condition.” Dispute is over “respecting.” Ordinary meaning of “respecting” is “about” or “related to.” Clearly, a statement about a single asset is “related to” a debtor’s financial condition. Lamar’s construction, which would limit the phrase to statements that capture a debtor’s overall financial status, reads “respecting” out of the statute. Lamar’s interpretation would render statute incoherent. No reason Congress would have wanted to distinguish between misrepresentation about an asset made in the context of a formal financial statement or balance sheet and same misrepresentation made on its own. Pre-Code practice supports Appling’s interpretation. Lamar’s policy arguments fail. It’s not true that giving a broader reading to “statement respecting a debtor’s financial condition” leaves little covered by “false pretenses, a false representation, or actual fraud,” which goes well beyond statements about financial condition. Moreover, Congress included the proviso that a statement respecting a debtor’s financial condition must be in writing to trigger non-dischargeability because creditors were manipulating debtors into making false statements in credit applications so they could claim non-dischargeability later. If creditor is relying on a debtor’s statement respecting his financial condition, all they need to do is get it in writing; if it later proves fraudulent, the debt will be non-dischargeable.

Questions: Did the Supreme Court’s ruling effectively eliminate the grounds for denial of discharge “for false pretenses, false statements, or actual fraud” if they are not in writing? Under what circumstances would “false pretenses, false statements, or actual fraud” not also involve a “statement respecting the debtor’s financial condition?” Are the examples of “false pretenses, false statements, or actual fraud” too narrow? It is interesting that the examples included false statements to governmental entities (e.g. Social Security Administration in In re Tucker, 539 B.R. 861, 868 ( Bankr . Idaho 2015)). Why is a misrepresentation about a debtor/stockbrokers’ investments not considered a “statement respecting the debtor’s financial condition? (See In re Bocchino , 794 F.3d 367 (3d Cir. 2015)). The Bankruptcy Court found there were two false statement. The second—that the Debtor had not received a refund—seems to be different from a statement respecting the Debtor’s financial position. Why didn’t the Supreme Court consider this argument? This case is more problematic to attorneys because it involved statements the Debtor made to his litigation counsel to induce him to continue representation as opposed to a creditor extending credit. Does this mean that attorneys have to get all information provided by their clients in writing and memorialize any conversations in writing in case the client later files bankruptcy?

Mission Prod. Holdings, Inc. v. Tempnology , LLC Certiorari Granted On One Question: Whether, under § 365 of the Bankruptcy Code, a debtor-licensor’s “rejection” of a license agreement—which “constitutes a breach of such contract,” 11 U.S.C. § 365(g)—terminates rights of the licensee that would have survived the licensor’s breach under applicable non-bankruptcy law. Argument scheduled for February 20, 2019

Mission Prod. Holdings, Inc. v. Tempnology , LLC History – the Lubrizol holding: In 1985, the Fourth Circuit Court of Appeals ruled in In re Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc. that the phrase “executory contract” in § 365(a) encompassed intellectual property licenses. As such, the court held that the “statutory breach” contemplated by § 365(g) controls and provides only monetary damages for the non-bankrupt counter-party. The licensee was not permitted to continue practicing the patent at issue.

Mission Prod. Holdings, Inc. v. Tempnology , LLC History – Response to Lubrizol : In 1988, Congress amended the Code to include § 365(n). According to the congressional record, this change was “to make clear that the rights of an intellectual property licensee to use the licensed property cannot be unilaterally cut off as a result of the rejection of the license pursuant to Section 365.” Section 365(n) provides that when a debtor rejects a contract “under which the debtor is a licensor of a right to intellectual property,” the licensee may elect either to treat the contract as terminated or to “retain its rights (including a right to enforce any exclusivity provision of such contract…) under such contract … to such intellectual property.” At the same time, Congress also amended the bankruptcy code definition of “intellectual property” to cover, among other things, patents, copyrights, and trade secrets but does not include trademarks.

Mission Prod. Holdings, Inc. v. Tempnology , LLC History – The Sunbeam holding In 2012, the Seventh Circuit Court of Appeals was the first to address the issue of rejected trademark licenses after the 1988 congressional amendments in Sunbeam Prod., Inv. V. Chicago Am. Mfg., LLC. The court held that rejection of the trademark license by the licensor/debtor does not terminate the licensee’s right to use the trademarks. It did so by rejecting the reasoning of Lubrizol because, in the Seventh Circuit’s view, the Lubrizol holding incorrectly equated the rejection of a license to an avoiding power rather than merely a breach under § 365(g). The court held that § 365(g)’s permission to breach the contract does not effect the rights the licensee would have had outside of bankruptcy upon the licensor’s breach. Thus, the Sunbeam court reasoned that whether trademarks are covered by § 365(n) has no bearing on the licensee’s ability to continue using the trademarks post-rejection.

Mission Prod. Holdings, Inc. v. Tempnology , LLC The Holding Below: The parties executed a Co-Marketing and Distribution Agreement that granted Mission several rights, including patent licenses, trademark licenses, and exclusive distribution rights to certain patented products. Tempnology filed for Ch 11 bankruptcy about 3 years later and moved to reject the agreement with Mission. Mission invoked § 365(n) in an attempt to retain the intellectual property rights granted by the agreement but the bankruptcy court only applied the exemption to the patent rights—not the exclusive distribution rights or the trademark licenses. The bankruptcy court reasoned that the decision to exclude trademarks from the bankruptcy definition of “intellectual property” left trademarks unprotected from rejection. The First Circuit BAP affirmed the bankruptcy court with respect to exclusive distribution rights but applied Sunbeam to the trademark licenses.

Mission Prod. Holdings, Inc. v. Tempnology , LLC The Holding Below: The First Circuit Court of Appeals agreed with the bankruptcy court on the trademark issue and reversed the BAP. It applied the Lubrizol reasoning and argued that Congress’s decision to add subsection (n) to § 365—rather than amending subsections (a) or (g) to clarify that a “breach” was no different than a breach occurring outside of bankruptcy—indicates that Congress recognized the purpose of subsection (g) is only to provide a damages remedy for the non-bankrupt party. Additionally, the court reasoned that this outcome was in line with the goal of bankruptcy to reduce the burden on the debtor because trademarks, unlike other forms of intellectual property, require the owner to monitor and exercise control over quality of goods sold under the trademark’s cover.

Mission Prod. Holdings, Inc. v. Tempnology , LLC Mission’s Position: Mission asks the Court to overturn the First Circuit’s decision and adopt the Sunbeam standard. It argues that the trustee or debtor-in-possession has avoiding powers in other sections of the Bankruptcy Code but that the power is limited to those sections. Mission also argues that Congress’s omission of trademarks from the Code’s intellectual property definition does not create an inference that trademark rights do not survive rejection. The International Trademark Association, among other amici, support Mission’s arguments.

Mission Prod. Holdings, Inc. v. Tempnology , LLC Tempnology’s Position: Tempnology focused its arguments on the assertions that trademarks are different than other forms of intellectual property because value inheres in conveying a message of continued monitoring and quality control by the licensor. Thus, continued use of the trademarks post-rejection by the licensee continues to impose costs and liability on the debtor as licensor. Additionally, Tempnology argues that Congress recognized and codified this distinction in the Bankruptcy Code’s definition of intellectual property.

Questions: If the Court reverses the holding below, how will the continued cost of monitoring and quality control be borne by debtors, even after rejection? Assumption and assignment? Sale of the trademark rights rather than rejection? What effect, if any, does each holding have on the value of the licenses? Should the Court affirm, what leverage do non-debtor licensees have in asserting rejection damages should the debtor licensor market the rejected trademark license anew? What about non-debtor licensees whose business is wholly reliant on the rejected licenses? What are their remedies besides filing bankruptcy?

Taggart v. Lorenzen (cert granted 1/4/19) Question Presented: Whether, under the Bankruptcy Code, a creditor’s good-faith belief that the discharge injunction does not apply precludes a finding of civil contempt. Opinion Below (9 th Cir.): Held that creditors did not knowingly violate the discharge injunction because they had a subjective good faith belief that the discharge injunction did not apply to their state court claim for post-petition attorneys’ fees. The creditors’ subjective good faith, even if unreasonable, insulated them from a finding of contempt. Ninth Circuit applies a two-part test to propriety of contempt sanction in context of discharge injunction: (1) Creditor knew the discharge injunction was applicable and (2) intended the actions violated the injunction. Circuit Split: First, Fourth and Eleventh Circuits hold that a creditor’s intent is not a defense to a finding of contempt.