Bankruptcy Report

Bankruptcy Report

How to Catch a Falling Giant: FIBA Moves Closer to Realization

Posted in FIBA

On July 6, 2016, the House of Representatives passed the Financial Institution Bankruptcy Act of 2016 (“FIBA”) as part of a larger financial services budget bill.  FIBA proposes to amend the Bankruptcy Code (the “Code”) to address the specific challenges that arise when a financial institution becomes insolvent.  The House Judiciary Committee’s report accompanying the bill concluded that, the bankruptcy process is not optimally designed for the orderly resolution of financial institutions. The Committee noted that the interconnectedness of financial institutions creates a potential for systemic risk to the broader financial markets, and, as was evident during the 2008 financial crisis, taxpayers are often called upon to prevent such risks.  FIBA, which would be located under a new subchapter V within Chapter 11 of the Code, confronts these challenges by seeking to improve the administration of financial institutions’ bankruptcy proceedings.

Legislative Background

FIBA is the culmination of a bipartisan process that solicited and incorporated the recommendations of industry participants, regulators, and leading experts.  Initially introduced and first passed in the House of Representatives in 2014, it failed to secure Senate approval.  Its chief sponsor, Representative David Trott, reintroduced FIBA in the 2015 House session, where it was subsequently referred to the House Judiciary Committee.  Following a hearing in July 2015, the House Judiciary Committee approved it by unanimous vote on February 11, 2016.  FIBA was then brought to the House floor under suspension of the rules, which requires a two-thirds vote for passage and allows no floor amendments.  On April 12, 2016, the House passed FIBA by voice vote. On July 6, 2016, the House passed a larger financial services budget bill, which included FIBA along with other regulatory provisions (such as congressional oversight of the Consumer Financial Protection Bureau).


a. Covered Financial Corporation

FIBA applies to Chapter 11 cases concerning “covered financial corporations”—corporations either incorporated or organized under any federal or state law as bank holding companies, or corporations that exist for the primary purpose of owning, controlling and financing their subsidiaries, that have total consolidated assets of $50 billion or greater, and whose annual gross revenues meet specified tests.

b. Speedy Transfer of Assets

The legislation allows a debtor holding company that sits atop a financial institution’s corporate structure to transfer the operating assets of the financial institution over the course of a weekend, enabling the financial institution to “continue to operate in the normal course, which preserves the value of the enterprise for the creditors of the bankruptcy without a significant impact on the firm’s employees, suppliers, and customers.”[1]  The debt, any remaining assets, and equity of the holding company would remain in the bankruptcy process and would absorb the financial institution’s losses.

Furthermore, the financial institution’s operating subsidiaries would remain out of the bankruptcy process, which would help multinational firms that might also need to comply with multiple, and potentially conflicting, insolvency regimes in other jurisdictions.

c. Appointed Judges

FIBA recognizes that the presiding bankruptcy judge must be comfortable overseeing cases involving financial institutions. Therefore, the judicial process of a subchapter V case would be presided over by a bankruptcy judge randomly chosen from a pool of ten bankruptcy judges selected by the Chief Justice of the Supreme Court based on their experience, expertise, and specialized knowledge of financial institutions.  In addition, a three-judge panel of Court of Appeals judges also appointed by the Chief Justice would preside over appeals.

d. Systemic Risks

To account for the potential for systemic risk in a subchapter V case, FIBA gives key financial regulators standing to present their views on pending motions to the presiding bankruptcy judge. The legislation also allows the bankruptcy judge, before issuing a final judgment on any motion, to consider the impact of a decision on financial stability in the United States.

e. Automatic Stay

The Code currently contains exemptions for counterparties to derivative and other structured transactions, allowing them to collect on outstanding debts from institutions in insolvency proceedings, ahead of other general creditors who must wait until a Chapter 11 plan is approved.  FIBA overrides these exemptions by imposing a 48-hour automatic stay that would allow for the effective transfer of the financial institution’s operations to a bridge company.

Without this exemption override, counterparties to derivatives and similarly-structured transactions could terminate their relationships with a financial institution debtor upon the commencement of a bankruptcy case, likely endangering the successful transfer and continued operation of the bridge company and potentially threatening other entities within the broader financial system.

f. Timing

Taking into account the fact that the bankruptcy of a financial institution must be resolved expeditiously to mitigate the exposure of risk to financial markets, FIBA includes specific timeframes for the commencement of a case and court approval of the transfer of assets to the bridge company.


The purpose of FIBA is to establish a transparent and predictable bankruptcy process for large financial institutions.  The legislation aims to prevent a situation similar to the 2008 financial crisis where, due to fears that the failure of financial firms could cause severe harm to the overall economy, the federal government provided taxpayer-funded assistance to prevent certain financial firms from failing.  FIBA seeks to ensure that shareholders and creditors of a financial institution, and not taxpayers, bear the risks and losses of a failed financial institution.  The legislation will proceed to the Senate for consideration.

[1] Diane Davis, “House Panel Approves Financial Institution Bankruptcy Act,” Bankruptcy Law Report (February 16, 2016),

A Retooled General Electric: An Industrial Giant That Is No Longer “Too Big To Fail”

Posted in Dodd-Frank, Financial Stability Oversight Council, Too Big To Fail

In May, we reported on the judicial rescission of MetLife’s designation as an entity “too big to fail,” and noted that the court’s decision provided designated companies with a framework to challenge their designation.  Another effective option is to fundamentally change the nature of the business, which is what GE Capital Global Holdings, LLC (“GE”) has done over the past three years.  As a result, on June 28, 2016, the Financial Stability Oversight Council (“FSOC”) determined that GE is no longer too big to fail and released GE from the heightened regulatory standards and oversight imposed upon designated entities.  This is first time FSOC has released an entity from the “SIFI” designation.

Three years ago, the FSOC identified GE as a systemically important institution whose failure would pose a threat to the country’s financial stability and accordingly, would be subject to a heightened level of regulatory scrutiny, additional capital requirements, and other government oversight. In response, however, GE transformed itself.  Working with FSOC staff to assure that its changes would result in a rescission as part of FSOC’s annual reevaluations of GE’s status, GE made deliberate and significant changes to its business to minimize the risk to the U.S. economy.  Its efforts included detangling itself from various financial markets, divesting business lines, and significantly restructuring its operations and corporate structure.  In March 2016, GE requested that FSOC rescind its designation.  Three months later, the FSOC agreed.  Now, only two non-financial institutions remain SIFIs, and experience has proven two paths to de-designation:  direct legal challenge or substantial, targeted business restructuring.

FSOC’s rescission of GE’s designation provides some insight into what factors matter most for liberating a company from the designation’s enhanced standards.  One takeaway is that it matters not just to reduce the size of the organization, but how that reduction minimizes potential threat to the country’s financial stability.  FSOC found that GE had “fundamentally changed its business” and become a “much less significant participant in financial markets and the economy.”  GE’s march to de-designation tracked the core areas of risk that FSOC identified when it first designated GE as too big to fail:

  • In 2013, GE had total assets that exceed $549 billion; now, it has divested more than 50 percent of those assets, while at the same time nearly tripling the percent of its liquid assets.
  • GE was once the most substantial player in the commercial paper market; now, its presence is nominal.
  • At one point, distress at GE could have caused money market funds to buck the dollar; now, no money market funds hold GE commercial paper, eliminating that risk.
  • GE once had lines of credit at over fifty banking institutions; now, GE has just a single line of credit to its parent, significantly reducing its direct interconnectedness with large financial institutions (though the parent has lines of credit at over forty banks).
  • GE’s financing operations had touched over 56 million consumers and businesses; now, its financing transactions relate only to its industrial activity (e.g., aircraft-related lending).
  • GE’s funding model had a significant (and systemically dangerous) focus on short-term funding; now, GE has increased reliance on long-term debt.
  • GE’s corporate structure was so complex that distressed restructuring would have been virtually impossible, with the ability to maintain going concern value sacrificed; now, GE has a simplified corporate structure that would lend itself to distressed restructuring, if necessary.

All this is not to say that GE is small, by any means:  the FSOC reiterated that GE remains a substantial and complex market participant.  The focused yet substantial shift in the nature and scope of GE activities, however, has extricated GE from SIFI status and will allow it to continue to sharpen its focus on its core industrials business.


SCOTUS Grants Cert in Jevic

Posted in Chapter 11, SCOTUS, Third Circuit

Yesterday, the Supreme Court granted certiorari in Czyzewski v. Jevic Holding Corp (“Jevic”). As previously reported, Jevic addressed whether a bankruptcy court can approve a settlement agreement that provides for distributions that violate the absolute priority rules as part of the structured dismissal of a chapter 11 proceeding. The Third Circuit held that such structured dismissals were appropriate even when they provided for distributions that do not strictly comply with the Bankruptcy Code’s absolute priority schemes.  The Third Circuit’s ruling is consistent with the Second Circuit’s holding in In re Iridium Operating LLC,[1] which held that such structured dismissals may be appropriate if they are justified by other factors, but put the Third Circuit in conflict with the Fifth Circuit, which held in Matter of AWECO, Inc.[2] that it was inappropriate to approve a structured dismissal that did not strictly comply with the absolute priority rule. The Supreme Court will now address this circuit split and decide whether the flexibility offered to debtors (and some creditors) by structured dismissals outweighs that impact that such dismissals can have on the rights of other creditors and interested parties as discussed in our prior post. The Supreme Court’s decision may also have a broader impact on non-priority distributions more generally and could affect the permissibility of “gift plans,” which are similar to the structured dismissals in Jevic as they often provide for secured or senior creditors to make payments to junior creditors in order to garner support for chapter 11 plans.  Check back with the HHR Bankruptcy Report as we continue to cover the briefing, developments, and potential impact of Jevic.

[1]               478 F.3d 452 (2d Cir. 2007)

[2]               725 F.2d 293 (1984).

Solicitor General Sides With Priority Creditors In Recent Amicus Brief

Posted in Chapter 11, SCOTUS, Section 1112, Third Circuit

Last summer, the HHR Bankruptcy Report analyzed the Third Circuit’s ruling in Official Committee of Unsecured Creditors v. CIT Group/Business Credit Inc. (In re Jevic Holding Corp.),[1] which approved, as part of the structured dismissal of a chapter 11 proceeding, a settlement agreement that allowed distributions that violated the absolute priority rule.  Following the Third Circuit’s ruling, the aggrieved priority creditors filed a writ of certiorari in the hope that the Supreme Court would address the split between the Courts of Appeals as to whether settlements must follow the absolute priority rule.[2] Now, in response to an invitation from the Supreme Court, the Solicitor General has submitted an amicus brief on behalf of the United States encouraging the Court to grant certiorari and to overturn the Third Circuit’s ruling.

The United State government has a particular and somewhat unique interest in having the Supreme Court review the Third Circuit’s decision. Federal taxing authorities (e.g. the IRS) are granted either second priority or eighth priority claims by the Bankruptcy Code depending on whether the tax obligation arose pre or post-petition. Accordingly, the government recognizes a real danger that, as a result of the Third Circuit’s ruling, debtors could collude with junior creditors to “squeeze out” government tax claims with a higher priority.

At issue in Jevic was the approval of a settlement agreement between the debtor, the Unsecured Creditors’ Committee and defendants to fraudulent transfer actions, that provided, in part, for (i) distributions to certain administrative and unsecured creditors as part of a structured dismissal of the chapter 11 proceeding, but did not provide for (ii) distributions to the debtor’s former employees who held higher priority claims arising from WARN Act liability. The former employees objected to the approval of the settlement on the ground that a bankruptcy court cannot approve a settlement and related structured dismissal of the case that does not comply with the order of priorities set out in section 507 of the Bankruptcy Code. Relying on the fact that it was highly unlikely that the debtor would confirm a plan of reorganization or that the employees would receive any distribution in a chapter 7 liquidation, the Third Circuit rejected the employees’ argument and held that a chapter 11 proceeding may be resolved, in rare circumstances such as those presented in the Jevic proceeding, through a structured dismissal that deviates from the Bankruptcy Code’s priority scheme.

The Solicitor General argued in his amicus brief that the Third Circuit had erred in reaching its holding for a number of reasons. First, the order of priorities established by the bankruptcy code reflects Congress’s detailed balancing of the rights and expectations of various creditor groups, and that by approving a settlement that deviated from this order of priorities, the bankruptcy court was upending “that carefully balanced system.” The Solicitor General noted that this outcome was particularly incongruous when compared to the requirements for chapter 11 plan confirmations and chapter 7 liquidations where priority creditors must be paid first (unless they consent to impairment). Second, the Solicitor General disagreed with the Third Circuit’s reasoning that a deviation from the Bankruptcy Code’s priority scheme was justified by the fact that the employees would not be prejudiced by the settlement because there was no prospect of a chapter 11 plan being confirmed or of a distribution to priority creditors if the case was converted to a chapter 7 liquidation (i.e. the employee creditors would be in the same position whether or not the settlement was approved). The Solicitor General noted that if the case had “simply been dismissed” pursuant to section 1112 of the Code, the employees could have pursued a fraudulent –conveyance action against the settling defendants on a derivative basis as creditors of Jevic. So rather than being outcome neutral, the employee creditors were being directly deprived of a potential source of recovery.  The Solicitor General also argued that granting certiorari was appropriate in this case because of the existing split between the Circuitx on this issue, as well as the real and significant impact the ruling could have on the rights of creditors in future proceedings.

The Solicitor General’s amicus brief highlights the potentially wide impact of the Third Circuit’s ruling, despite the court’s attempt to limit its holding to cases where “specific and equitable grounds” justify deviation from the priority scheme. It is conceivable that in nearly every case where a debtor is administratively insolvent, a justification could be found for deviating from the absolute priority rule under the Third Circuit’s ruling.  In those circumstances, debtors will be able to apply strong bargaining pressure on priority creditors to accept reduced claim amounts, less the debtor strike a settlement with other junior creditors of the case that cuts out the recalcitrant priority creditor entirely.  Additionally, in light of the Circuit split on the issue, the Third Circuit’s ruling raises forum shopping concerns, as debtors (many of whom are organized under the laws of Delaware) will be more likely to commence proceedings in the Delaware bankruptcy court, if only to ensure themselves the benefit of the debtor-friendly rule adopted by the Third Circuit.

Check back with us in the future as we will to continue to cover developments in Jevic.

[1]         787 F.3d 173 (3rd Cir. .2015).

[2]         Compare In re AWECO, Inc 725 F.2d 293 (5th Cir 1984)(finding that a bankruptcy court abuses its discretion in approving a settlement agreement that does not comply with the absolute priority rule); with In re Irdium Operating LlC, 478 F.3d 452 (2d Cir. 2007) (holding that a settlement may deviate from the absolute priority rule in certain circumstances).

Fraud is Broad: SCOTUS Declines to Accept Narrow Interpretation of “Actual Fraud” in 11 U.S.C. § 532(a)(2)(A)

Posted in Fifth Circuit, SCOTUS, Section 523(a)(2)(A)

Last November, the HHR Bankruptcy Report reported on the Supreme Court’s grant of the petition for certiorari in Husky International Electronics, Inc. v. Ritz, a case in which the Fifth Circuit had held that “actual fraud” under section 523(a)(2)(A) of the Bankruptcy Code (which limits the breadth and effect of a debtor’s discharge) required proof of a false representation.  Earlier today, in a 7-1 decision, the Supreme Court issued its opinion, reversing the Fifth Circuit’s holding and ruling that actual fraud encompasses “fraudulent conveyance schemes, even when those schemes do not involve a false representation.”

In holding that actual fraud “encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation,” the Supreme Court looked to congressional intent and the historical meaning of actual fraud. As to congressional intent, the Court explained that before 1978, the Bankruptcy Code prohibited debtors from discharging a debt obtained by “false pretenses or false representations.”  In the Bankruptcy Reform Act of 1978, Congress changed the statute such that a debtor cannot discharge a debt obtained by “false pretense, a false representation, or actual fraud.”  As Justice Sotomayor explained, it can be presumed “that Congress did not intend ‘actual fraud’ to mean the same thing as a ‘false representation,’ as the Fifth Circuit’s holding suggests.”

Turning to the historical meaning of actual fraud, the Court began its analysis by quoting the original Elizabethan language of the one of the first bankruptcy statutes, the Statute of 13 Elizabeth, also known as Fraudulent Conveyances Act of 1571, which “identified as fraud ‘feigned convenous and fraudulent Feoffmentes Gyftes Grauntes Alientations [and] Conveyaunces’ made with “Intent to delaye hynder or defraude Creditors.’” The Court noted that the principles behind the 1571 Act, which make it fraudulent to hide assets from creditors by giving them to one’s family or friends, are still used and “embedded in laws related to fraud today.”  This, the Court explained, “clarifies that the common-law term ‘actual fraud’ is broad enough to incorporate a fraudulent conveyance.”  Further, the fact that, under the 1571 Act and laws that followed, both the debtor and recipient of the assets are liable for fraud, underscores the notion that a “false representation has never been a required element of ‘actual fraud.’”

The Court also rejected the debtor’s argument that the Court’s interpretation would create a redundancy with section 727(a)(2), which prevents a debtor from discharging all debts if, within the year preceding the filing of the petition, the debtor transferred or concealed its assets for the purposes of hindering, delaying, or defrauding a creditor. The Court noted that the two sections may overlap, but that section 727(a)(2) is broader in scope because it prevents an offending debtor from discharging all debt in bankruptcy, and is narrower in timing as it applies only if the debtor fraudulently conveys assets within a year preceding the filing of the petition. Therefore, unlike section 727(a)(2), section 523(a)(2)(A) is tailored as a remedy for behavior connected only to specific debts.

In dissent, Justice Thomas opined that “actual fraud” in section 523(a)(2)(A) “does not apply so expansively” to include fraudulent transfer schemes effectuated without any false representation. Although he agreed with the majority that the common law definition of “actual fraud” included fraudulent transfers, he explained that the general rule that a common law term of art should be given its established common law meaning must give way where the meaning does not fit.  Here, according to Justice Thomas, “context dictates” that actual fraud does not include fraudulent transfers because that meaning fails to fit with the rest of section 523(a)(2).

Risk is in the Eye of the Beholder: Court Reconsiders “Too Big to Fail” Designation of MetLife, Inc.

Posted in Dodd-Frank, Financial Stability Oversight Council

The determination by the Financial Stability Oversight Council (“FSOC”) that MetLife, Inc. (“MetLife”) could “pose a threat to the financial stability of the United States” was recently rescinded by the District Court for the District of Columbia.[1] Administrative law provided the grounds for the court’s conclusion that, in designating MetLife as “too big to fail,” FSOC failed to follow: (1) recent Supreme Court precedent requiring consideration of the costs and benefits of an administrative action; and (2) the agency’s own guidance.  The court’s decision provides a framework for other designated companies who have received a similar designation and seek to challenge that status.[2]  The decision also poses a hurdle for further designations by FSOC, which, in addition to following its own guidance, must consider whether the costs of designation to the company outweigh the benefits of heightened regulation.


Dodd-Frank[3] established FSOC to, among other things, identify risks to financial stability in the United States that could “arise from the material financial distress or failure” of nonbank financial companies.[4]  A nonbank financial company designated by FSOC as too big to fail becomes subject to Federal Reserve supervision and heightened regulatory standards, such as higher capital requirements.  In 2012, FSOC issued the Guidance for Nonbank Financial Company Determinations (the “Guidance”), which organized ten statutory factors into six categories, further subdivided into two groups.[5]  FSOC intended the first group “to assess the potential impact of the nonbank financial company’s financial distress on the broader economy,” and the second group “to assess the vulnerability of a nonbank financial company to financial distress.”

In 2014, after more than a year of meetings between FSOC and MetLife, the evaluation of more than 21,000 pages of materials, and a hearing, FSOC designated MetLife as a “nonbank financial company.” FSOC anchored its conclusion on four findings:  (1) exposed counterparties would potentially suffer substantial losses if MetLife underwent material financial distress; (2) this financial distress would potentially cause MetLife to liquidate assets rapidly, upsetting capital markets; (3) the existing regulatory framework would not stop either (1) or (2) from occurring; and (4) “MetLife’s complexity would hamper its resolution and thus ‘prolong uncertainty, requiring complex coordination among numerous regulators, receivers, or courts that would have to disentangle a vast web of intercompany agreements.’”  With this designation, MetLife joined the ranks of American International Group, Prudential Financial Inc., and General Electric, the only other entities to have been designated nonbank financial companies.

MetLife filed a complaint against FSOC challenging the designation. On March 30, 2016, the District Court found that FSOC’s determination was “arbitrary and capricious” and rescinded MetLife’s designation.

Standard of Review

Under Dodd-Frank, district courts may rescind FSOC’s designation only upon a conclusion that it was “arbitrary and capricious.” This narrow and highly deferential standard of review requires only that the court find a rational basis for FSOC’s decision.  To rescind, the court must find that FSOC departed from its prior policy or rules without providing sufficient justification.

With respect to MetLife, the District Court concluded that FSOC’s designation process was “fatally flawed.” FSOC “critical[ly] depart[ed]” from standards previously adopted in its guidance, and FSOC’s intentional disregard of the “downside cost” considerations to designating MetLife ignored recent Supreme Court standards.

Cost-Benefit Analysis Necessary For Dodd-Frank Administrative Decisions

FSOC’s intentional exclusion of cost considerations rendered its determination arbitrary and capricious under recent Supreme Court precedent. The Supreme Court’s decision in Michigan v. Environmental Protection Agency provided that cost-benefit analyses may be imputed:  a statute’s use of the word “appropriate” “naturally and traditionally includes consideration of all relevant factors.” [6]  The Supreme Court found cost to be an “important aspect of the problem” and noted that “any disadvantage could be termed a cost.”  In its analysis, however, FSOC ignored cost considerations, arguing that Dodd-Frank does not require FSOC to perform a cost-benefit analysis.

MetLife argued that the heightened regulatory standards associated with its designation would “impos[e] billions of dollars in cost [that] could actually make MetLife more vulnerable to distress.” FSOC’s designation actually did “foist[] ‘billions of dollars’ of regulatory costs” upon MetLife.  The District Court explained that, because the “cost-benefit analysis is a central part of the administrative process,” “cost must be balanced against benefit because ‘[n]o regulation is ‘appropriate’ if it does significantly more harm than good.”[7]  The District Court found it “impossible” to determine whether FSOC’s designation of MetLife as systemically important “does significantly more harm than good.”  Significantly, the District Court anticipated that the line of cases on which FSOC anchored its disregard of cost is unlikely to survive Michigan.

FSOC’s Process “Critically” Departed From Its Guidance

The District Court determined that FSOC’s analysis deviated materially from the analytical, dual-group process established in the Guidance. FSOC ignored the grouping entirely and applied all six categories as if they “were meant only ‘to assess the potential effects of a company’s material financial distress.’”  The court found this to be “undeniably inconsistent” and “inarguably different” from the framework established by the Guidance.  According to the District Court, “[t]he distinction [in the Guidance] was clear:  FSOC intended the second group of analytical categories to assess a company before it became distressed and the first group to assess the impact of such distress on national financial stability.”

The District Court also found that, when analyzing MetLife’s potential threat to the financial system, FSOC failed to apply the standards delineated in the Guidance. The Guidance interpreted the statutory phrase “could pose a threat to the financial stability of the United States”[8] to mean that a nonbank financial company could only be deemed a threat “if there would be an impairment of financial intermediation or of financial market functioning that would be sufficiently severe to inflict significant damage on the broader economy.”[9]  The Guidance explains that “significant damage on the broader economy” could occur through one of three “transmission channels:” (1) exposure,[10] (2) asset liquidation,[11] or (3) critical function or service.[12]  The District Court concluded that FSOC not only failed to “abide by that standard,” it “hardly adhered to any standard when it came to assessing MetLife’s threat to U.S. financial stability.”  For example, in its analysis of the exposure channel, FSOC “merely summed gross potential market exposures” while failing to consider mitigating factors, like collateral.  FSOC also applied the phrase “could sustain losses” throughout its analysis, but it neglected to quantify the losses in any way.  Such generalized assumptions were found to “pervade the analysis” so that “every possible effect of MetLife’s imminent insolvency was summarily deemed grave enough to damage the economy.”  The District Court concluded that, although the mode of thinking reflected by FSOC’s analysis was “entirely consistent” with Dodd-Frank, it “was not the standard invoked by FSOC.”  And thus, FSOC’s assumption of damage, without explaining how it would result, was “in contravention of the Guidance.”

Final Considerations

The Court’s rescission of FSOC’s determination provides two potential paths for institutions seeking to avoid or appeal a designation of systemic importance. If an entity can show that the costs of heightened regulation exceed the potential benefit of that regulation, FSOC’s determination can potentially be avoided or rescinded.  The necessity of a cost-benefit analysis may be the linchpin entities need to argue against designation under Dodd-Frank.  Furthermore, because the MetLife decision presents the Guidance as FSOC’s roadmap for designation, companies should look closely at the Guidance to assure that their operations do not lend themselves to designation or that a designation has not been inappropriately made.

[1].      MetLife, Inc. v. Financial Stability Oversight Council, Civil Action No. 15-0045 (RMC) (D.D.C. March 30, 2016).

[2].      Shortly after the MetLife decision, General Electric—one of four nonbank entities to ever earn the designation—filed a request with FSOC for the rescission of its designation as too big to fail.

[3].      Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376-2223, codified at 12 U.S.C. §§ 5301 et seq. (2010)

[4].      FSOC consists of the heads of certain federal financial regulatory bodies, including the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve System, the Chairman of the Securities and Exchange Commission, and the Chairperson of the Federal Deposit Insurance Corporation.

[5].      77 Fed. Reg. 21,637 (FR); codified at 12 C.F.R. § 1310. The six categories are:  interconnectedness, substitutability, size, leverage, liquidity risk and maturity mismatch, and existing regulatory scrutiny.  76 Fed. Red. 4,555 (Jan 26, 2011).  12 C.F.R. § 1310 App. A.II.d.

[6].      Michigan v. Environmental Protection Agency, 135 S. Ct. 2699 (2015).

[7].      The Federal Reserve recently proposed a new rule that would affect financial contracts like those that destabilized financial markets after Lehman Brothers Holdings, Inc.’s 2008 collapse.  The proposed rule preemptively applies the cost-benefit analysis required by Michigan and is intended to reduce the risk when large financial institutions fail.  It explicitly considers the relatively small cost of the rule against the benefits to financial stability. See Restrictions on Qualified Financial Contracts of Systemically Important U.S. Banking Organizations and the U.S. Operations of Systemically Important Foreign Banking Organizations; Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions, 12 CFR Parts 217, 249, and 252.

[8].      12 U.S.C. § 5323(a)(1).

[9].      12 C.F.R. §1310 App. A.II.a.

[10].    The Guidance defines the “exposure channel” to mean: “A nonbank financial company’s creditors, counterparties, investors, or other market participants have exposure to the nonbank financial company that is significant enough to materially impair those creditors, counterparties, investors, or other market participants and thereby pose a threat to U.S. financial stability.” 12 C.F.R. §1310 App. A.II.a.

[11].    The Guidance describes how financial distress could destabilize the U.S. through the “asset liquidation channel”:  “A nonbank financial company holds assets that, if liquidated quickly, would cause a fall in asset prices and thereby significantly disrupt trading or funding in key markets or cause significant losses or funding problems for other firms with similar holdings.  This channel would likely be most relevant for a nonbank financial company whose funding and liquid asset profile makes it likely that it would be forced to liquidate assets quickly when it comes under financial pressure.”  12 C.F.R. §1310 App. A.II.a.

[12].    Op. at 9; 12 C.F.R. §1310 App. A.II.a.

Chapter 11 Debtors Exempt From Their Obligations Under An Expired Collective Bargaining Agreement

Posted in Chapter 11, Section 1113, Third Circuit

The Third Circuit’s decision in In re Trump Entertainment presents interesting opportunities for employers with expired collective bargaining agreements (“CBAs”) seeking to reorganize their companies under Chapter 11 of the Bankruptcy Code. [1] In In re Trump Entertainment, the Court held that a debtor may reject an expired CBA under Section 1113 of the Bankruptcy Code despite the specific limitations on such rejections contained in the National Labor Relations Act (“NLRA”). The Third Circuit’s ruling may provide extra bargaining power and flexibility to companies whose reorganization efforts are impacted by CBAs and labor disputes.

In Trump Entertainment, the debtors were the owners and operators of the Trump Taj Mahal Casino. In 2011, they had entered into a CBA that required the debtors to contribute $3.5 million per year to its pension and an additional $10-12 million per year for healthcare and welfare expenses.  A few months prior to expiration of the CBA, the debtor and its union engaged in good faith negotiations to amend and extend the CBA. However, these negotiations ultimately proved unsuccessful and by September 2014, the debtor had $286 million in secured debt and only $12 million in working capital.  As a result, the debtor filed for Chapter 11 bankruptcy and as soon as the CBA expired moved to reject the CBA under Section 1113 of the Bankruptcy Code. The Bankruptcy Court granted the debtor’s motion effectively rendering the expired CBA unenforceable and freeing the debtor from the pension and healthcare funding obligations.  The union promptly filed a direct appeal to the Third Circuit.

This case presented a matter of first-impression as it involved a conflict between two federal statutes; Section 1113 of the Bankruptcy code, and the NLRA. The NLRA states that an employer cannot unilaterally change the terms of a CBA even after it expires.[2] In contrast, Section 1113 of the Bankruptcy Code allows a debtor to reject its CBA if: (i) the debtor proposed modifications to its CBA that would allow the company to successfully reorganize; (ii) the employees’ authorized representative rejected the employer’s proposals; and (iii) the bankruptcy court determined that the “balance of equities clearly favors” rejecting the CBA.[3] The debtor argued that there should be no distinction between unexpired CBAs and expired CBAs under Section 1113 of the Bankruptcy Code and therefore it was entitled to reject the contract as it had satisfied the other requirements of Section 1113. In contrast, the union argued that an expired CBA could not constitute a “contract” which could be rejected under the terms of Section 1113 of the Bankruptcy Code.

The Court broadly reviewed the legislative purpose behind both statutes before holding that there should be no distinction between expired and unexpired CBAs under Section 1113 of the Bankruptcy Code. In further support for its holding, the Third Circuit noted that this was consistent “with the purpose of the Bankruptcy Code which gives debtors latitude to restructure their affairs.”[4] The Court expanded on this holding by noting that it is preferable for a company to reject its CBA for the sake of preserving jobs than adhering to the stringent terms of its CBA which results in the permanent loss of jobs.[5]

The Third Circuit’s decision may help strengthen reorganizing corporations bargaining position as it expands their ability to shed continuing obligations under an expired CBA. Although this comes at the expense of unions’ potential negotiating positions, a potential debtor’s power is still tempered by the fact that the potential debtor must comply with the strict procedural requirements of Section 1113 of the Bankruptcy Code.

[1] 810 F.3d 161 (2016).

[2] 29 U.S.C. 158(a)(5)

[3] 11 U.S.C. § 1113

[4] Id. at 173.

[5] Id. at 174.

Follow the Rules: 11th Circuit Holds that District Court Must Follow Federal Rules of Bankruptcy Procedure on Rule 50(b) Motion

Posted in Eleventh Circuit, FRBP, FRCP

On April 8, 2016, the Eleventh Circuit Court of Appeals held that a district court trying a bankruptcy case arising under title 11 of the United States Code is obliged to follow the Federal Rules of Bankruptcy Procedure, instead of the Federal Rules of Civil Procedure, in computing the deadline for filing post-trial motions.

The story behind this procedural ruling began eight years earlier, when several companies filed an involuntary chapter 7 bankruptcy petition against Maury Rosenberg.  The bankruptcy court granted Rosenberg’s motion to dismiss the petition with prejudice because the companies were not eligible creditors.  The bankruptcy court retained jurisdiction to award Rosenberg his costs, reasonable attorney’s fees, and damages under section 303(i) of the Bankruptcy Code.  Rosenberg then filed an adversary complaint against the defendants seeking: (1) attorney’s fees and costs for defending the involuntary petition, (2) compensatory and punitive damages for filing the petition in bad faith, and (3) attorney’s fees incurred in the prosecution of the adversary proceeding.  The district court granted the defendants’ motion to withdraw the reference because the claims for damages under section 303(i)(2) of the Bankruptcy Code were analogous to common-law claims for malicious prosecution.  The damages claims were tried before a jury in district court; Rosenberg’s claims for attorney’s fees and costs remained in bankruptcy court.

The jury found that the defendants acted in bad faith and awarded Rosenberg compensatory and punitive damages, and on March 14, 2013, the district court entered final judgment.  Twenty-eight days later, defendants moved for judgment as a matter of law under Fed. R. Civ. P. 50(b).  Rosenberg moved to strike the motion as untimely, arguing that the deadline for filing a Rule 50(b) motion under Fed. R. Bankr. P. 9015(c) was fourteen days after entry of the judgment.

The Eleventh Circuit addressed whether the Federal Rules of Civil Procedure or the Federal Rules of Bankruptcy Procedure supplied the deadline for filing a Rule 50(b) motion for a district court trying a bankruptcy case arising under title 11.  First, the court noted that a “plain reading” of the Federal Rules of Bankruptcy Procedure make clear that the Federal Bankruptcy Rules have primacy in cases arising from title 11, and that the Federal Rules of Civil Procedure only apply to the extent that they have been explicitly incorporated by the Bankruptcy Rules.  Therefore, F.R.C.P. 50(b) must be read “through the lens” of the Bankruptcy Rules, which incorporates F.R.C.P. 50(b), with the “explicit limitation that renewed motions for judgment must be filed within 14 days of the entry of the judgment.”  See Fed. R. Bankr. P. 9015(c).

Next, although the precise question had not been decided by other district or circuit courts, the Eleventh Circuit found guidance in decisions of other courts for holding that the Federal Rules of Bankruptcy Procedure apply.  For example, both the Fourth and Seventh Circuits have applied the Bankruptcy Rules in determining whether service of process was sufficient.  See In re Celotex Corp., 124 F.3d 619, 630 (4th Cir. 1997); Diamond Mortg. Corp. v. Sugar, 913 F.2d 1233, 1243-44 (7th Cir. 1990).  In addition, the Third Circuit ruled in Phar-Mor, Inc. v. Coopers & Lybrand, 22 F.3d 1128, 1238 (3d Cir. 1994) that “Bankruptcy Rules govern non-core, ‘related to’ proceedings before a district court.”  Also relevant was a decision by the District of Delaware in which the district court concluded that the Federal Rules of Bankruptcy Procedure apply in counting the days to determine the timeliness for filing a motion for a new trial, rather than the Federal Rules of Civil Procedure, which do not count weekends and holidays.  VFB LLC v. Campbell Soup Co., 336 B.R. 81 (D. Del. 2005).

The Eleventh Circuit rejected the cases cited by defendants.  Although the Sixth Circuit has applied a 28-day filing deadline from the Federal Rules of Civil Procedure instead of the 14-day deadline in the Bankruptcy Rules with regard to a motion to alter or amend a judgment under Fed. R. Civ. P. 59, the Eleventh Circuit explained that in that case, the court provided “no analysis of the issue” and explained that there was “no indication that the parties urged or that the court even considered applying the deadline found in the Bankruptcy Rules.”  Therefore, that case did not support applying the Federal Rules of Civil Procedure to a case arising under title 11.  The Eleventh Circuit also noted that applying the 14-day deadline “does not create an overly onerous obligation on parties proceeding in district court any more than it does in bankruptcy court.”

The Eleventh Circuit also rejected defendants’ argument that even if the 14-day deadline was applied, the time did not begin to run until the bankruptcy court entered the final judgment on Rosenberg’s claims for attorney’s fees.  The court was “unpersuaded” and explained that because the matters were tried by different judges, on different courts, operating under different timetables set by their respective dockets, deeming the two cases as one for purposes of when an appeal may be taken “makes little sense.”

The decision provides clear guidance for practitioners litigating bankruptcy claims in district court.  Finding that “both the plan language of the rules and the weight of authority counsel for the application of the Bankruptcy Rules to bankruptcy proceedings tried in district court,” the Eleventh Circuit’s decision has potentially broader applicability to other procedural deadlines as well.

Delaware Bankruptcy Court Rejects Attempt to Indemnify Committee Counsel for Costs of Defending Fees

Posted in Delaware, Professional fees, Section 328(a)

In In re Boomerang Tube, Inc.,[1] the United States Bankruptcy Court for the District of Delaware refused to approve a proposed retention application that would have required the bankruptcy estate to reimburse counsel for the committee of unsecured creditors for fees and expenses the counsel incurred in any successful defense of their fees in the case.  The Bankruptcy Court ruled that such an arrangement was impermissible under the Bankruptcy Code and in contravention of the Supreme Court’s 2015 ruling in Baker Botts L.L.P. v. ASARCO LLC.[2]  The Bankruptcy Court’s decision poses implications for professionals faced with the prospect of defending their fees in bankruptcy cases, who may now be compelled to shoulder the expenses of a potential fee defense even if they have negotiated contractual provisions for the reimbursement of such fees.

In Boomerang Tube, the Official Committee of Unsecured Creditors (the “Committee”) retained counsel (“Committee Counsel”) pursuant to a retention agreement, which provided that Committee Counsel would be indemnified for any fees and expenses incurred while successfully defending potential challenges to their fees.  The Committee sought approval of the retention agreement pursuant to section 328(a) of the Bankruptcy Code.

The U.S. Trustee (the “UST”) objected to the fee defense provisions on three principal grounds.  First, the UST argued that the provisions were barred by the ruling in ASARCO, in which the Supreme Court held that a law firm cannot recover fees from a bankruptcy estate for its defense against an objection to its fees.  Second, the UST argued that section 328(a) of the Bankruptcy Code did not create an exception to the “American Rule” that requires each litigant to pay its own attorney’s fees.  Third, the UST contended that the proposed fee defense provisions were impermissible under section 328(a) because they were unreasonable and sought to compensate Committee Counsel for work outside the scope of their employment.

In response, the Committee first argued that ASARCO was distinguishable because it held only that section 330(a) of the Bankruptcy Code did not contain an express exception to the American Rule, whereas the Committee sought approval of the proposed fee defense provisions pursuant to section 328(a).  Second, the Committee asserted that the Supreme Court’s ruling in ASARCO did not preclude a contractual exception to the American Rule.  Third, the Committee contended that the proposed fee defense provisions were permissible under section 328(a), citing numerous bankruptcy cases in which indemnification provisions for successfully defending fees were approved.

The Bankruptcy Court rejected each of the Committee’s arguments and denied the Committee’s request for approval of the fee defense provisions in Committee Counsel’s retention agreement.  First, the Bankruptcy Court found that although section 328(a) of the Bankruptcy Code provided an exception to section 330, it did not authorize the fee defense provisions at issue because section 328(a) did not contain the “specific and explicit” statutory exception to the American Rule required under the ASARCO ruling.

Second, the Bankruptcy Court acknowledged the possibility of a contractual exception to the American Rule, but concluded that the proposed fee defense provisions were nonetheless impermissible because they were inconsistent with the Bankruptcy Code.  The Bankruptcy Court observed that the retention agreement was a contract between the Committee and Committee Counsel that called for a third party—the bankruptcy estate—to pay the Committee Counsel’s defense costs.  Because the retention agreement could not bind a non-party to the agreement, the Bankruptcy Court held the proposed fee defense provisions to be unenforceable.  The Bankruptcy Court also noted that retention agreements in bankruptcy proceedings are not simply contractual matters, but are also subject to objections by other parties and ultimately require court approval in accordance with the provisions of the Bankruptcy Code, regardless of the terms of the agreement.

Third, the Bankruptcy Court considered whether, even if ASARCO did not preclude the proposed fee defense provisions, they could be approved under section 328(a).  The Court agreed with the UST that the provisions did not constitute “reasonable terms and conditions of employment” for Committee Counsel under section 328(a), because defending their own fees would be a service performed by Committee Counsel only for their own interests, not for the Committee itself.  The Bankruptcy Court was also unpersuaded by the Committee’s reference to similar indemnification provisions that were approved in other cases.  The cases the Committee relied upon predated the ASARCO decision, which expressly rejected the consideration of such market factors in determining whether defense fees can be recovered.

Boomerang Tube presents a warning for all professionals involved in bankruptcy cases—not solely committee counsel—in drafting fee defense provisions in a retention agreement.  The Bankruptcy Court noted that it would deny approval of a retention agreement “filed by any professional under section 328(a)—including one retained by the debtor” that shifted fees incurred by the professional in defending fee objections.[3]  Other courts may follow this reasoning, and bankruptcy professionals may attempt other methods of circumventing ASARCO’s restrictions; the HHR Bankruptcy Report will continue to provide updates on further developments in this regard.

[1]       In re Boomerang Tube, Inc., No. 15-11247, 2016 WL 385933 (Bankr. D. Del. Jan. 29, 2016).

[2]       Baker Botts L.L.P. v. ASARCO LLC, 135 S. Ct. 2158 (2015).

[3]       In re Boomerang Tube, 2016 WL 385933 at *8 n.6.

Guidance on the Scope of Airline Debtors’ “Surrender and Return” Obligations Under Section 1110 of the Bankruptcy Code

Posted in Aviation, Chapter 11, Section 1110

Section 1110 of the Bankruptcy Code provides special protections to lenders and lessors that lease, finance, or conditionally sell aircraft equipment.  In 2000, Congress amended section 1110 to add section 1110(c), which provides that a debtor must “immediately surrender and return” aircraft equipment to a secured party if such party is entitled to possession under section 1110(a)(1).  Since Congress’ passage of this provision in 2000, debtor airlines and aircraft financiers in airline bankruptcies have disputed how an airline debtor’s “surrender and return” obligations should be interpreted and enforced.  Aircraft financiers have argued that “surrender and return” requires the airline debtor to deliver an intact and airworthy aircraft to the location of the financier’s choosing in the condition required under the underlying documents.  Airline debtors have argued that “surrender and return” merely requires that the aircraft be made available to the aircraft financier at any location and in any condition.

On April 8, 2016, in the first written decision in In re Republic Airways Holdings, Inc., Judge Sean Lane of the U.S. Bankruptcy Court for the Southern District of New York issued a decision providing guidance on the scope of an airline debtors’ “surrender and return” obligations, holding that “[t]he court will not require the Debtors return the aircraft and related equipment in particular condition for surrender and return.”[1]

The dispute regarding the scope of Republic’s “surrender and return” obligations arose as a result of Republic’s motion seeking to surrender and return aircraft equipment that served as collateral under a loan agreement with Citibank because the aircraft collateral was not required for its long-term business plan.  Citibank did not object to Republic’s business judgment or discretion under Sections 365 or 544 of the Bankruptcy Code—the provisions that allow a debtor, respectively, to assume or reject executory contracts or unexpired leases, and to abandon the estate’s burdensome property of inconsequential value and benefit after notice and a hearing.[2]  Instead, Citibank argued that the procedures under which Republic actually proposed to perform the “surrender and return” of the aircraft collateral did not satisfy Section 1110(c) of the Code because, among other things, the engines subject to Citibank’s security interest were not installed on the correct airframe and in some cases in different locations than the airframes.[3]

Faced with this objection, and noting that “there’s not a lot of case law out there,”[4] Judge Lane issued a published decision interpreting the “frequently disputed” section 1110(c) of the Code.[5]  Relying, in part, on a decision issued in the US Airways bankruptcy in the Eastern District of Virginia and lengthy bench decisions issued in the Northwest Airlines and Delta bankruptcies, Judge Lane rejected most of Citibank’s objections.[6]

The Court refused to require the Debtors to return the aircraft with the matching Citibank engines—which would have been “akin to” forcing the Debtors to comply with the agreement’s conditions for return.[7]  The Court noted that bankruptcy courts have rejected similar requirements in several other airline bankruptcy cases: namely US Airways, Northwest Airlines, and Delta Air Lines.[8]  Courts have variously found these requirements to be counterintuitive, costly, and burdensome to debtors, their estates, and their creditors.[9]

Judge Lane held that instead of splitting the costs for any engine replacements now, Citibank may instead file a claim for the expenses it incurs for costs associated with the surrender and return of its aircraft and engine collateral.[10]  Citibank suggested that—rather than leave the cost determination to a later date in the claims process—the parties split the costs associated with the surrender and return now.[11]  Relying on the reasonableness standard that courts use to address surrender and return of aircraft collateral, the Court held that splitting costs at this early stage is inappropriate—first, because the Court lacked sufficient information about the condition of the aircraft and engines at issue, and second, because Citibank failed to take prompt action to address the surrender and return of the aircraft at issue.[12]  The Court held, “A claim filed by Citibank—and any resulting decision on that claim—will be a more accurate reflection of the true burdens associated with the surrender and return process than a simple splitting of the costs.”[13]

This decision provides necessary guidance on the scope of an airline debtor’s “surrender and return” obligations, which will help debtors make fleetplan decisions in the early days of the case, as required under section 1110 of the Bankruptcy Code and defer litigation and negotiation regarding the proper allocation of expenses to the claims reconciliation process.

[1].      Mem. of Decision, 8, Case No. 16-10429 (SHL) (Bankr. S.D.N.Y. Apr. 8, 2016), ECF No. 323.

[2].      Id. at 5.

[3].      Id.

[4].      See Hearing Transcript of March 22, 2016 at 83:1-7 [ECF No. 225].

[5].      Id. (citing In re US Airways Grp., Inc., 287 B.R. 643, 645 (Bankr. E.D. Va. 2002); In re Northwest Airlines Corp., Case No. 05-17930 (Bankr. S.D.N.Y. Oct. 7, 2005), Hearing Transcript of October 7, 2005 at 40:9–41:24, ECF No. 1847.).

[6].      Id. at 8.

[7].      Id.

[8].      Id. at 8-10.

[9].      Id. at 9-10

[10].    Id. at 10-11.

[11].    Id. at 11-12.

[12].    Id. at 11.

[13].    Id. at 11-12.