Cambridge Analytica filed for bankruptcy under Chapter 7 of the Bankruptcy Code late last week and recently announced that it will be shutting down. We will be monitoring the case for interesting bankruptcy litigation updates that are expected to arise.  Cambridge Analytica was a political consulting firm that came under fire related to private data of Facebook users.

Closed SignThe case was filed in the U.S. Bankruptcy Court for the Southern District of New York and the voluntary petition is available here.  The petition lists assets of up to $500,000 and liabilities in the range of $1 million to $10 million.

In addition, several of Cambridge Analytica’s affiliates have also filed for bankruptcy in the Southern District of New York as well as in the High Court of Justice, Business and Property Courts of England and Wales.  SCL USA, Inc. also filed a Chapter 7 petition in the Southern District of New York.

Here are a few additional articles on the filing —

We will continue to monitor as this case develops.

Recently, the U.S. Bankruptcy Court for the Eastern District of Pennsylvania clarified that funds returned to the debtor are not recoverable as intentional fraudulent transfers.  See Holber v. Nikparvar (In re Incare, LLC), Adv. No. 14-0248 (Bankr. E.D.Pa. May 7, 2018).

The Debtor, Incare, LLC, was a medical care provider that provided services to a variety of hospitals and medical facilities in Pennsylvania.  After Incare filed for bankruptcy in 2013, a chapter 7 trustee brought a fraudulent transfer case against the managing and sole member of Incare, his wife, and related entities seeking to avoid and recover fraudulent transfers pursuant to Sections 544 and 550 of the U.S. Bankruptcy Code.

Liberty Bell
Liberty Bell, Philadelphia, PA

Section 544 allows a trustee to avoid a transfer that would otherwise be avoidable by the debtor’s creditors under applicable state law, in this case, the Pennsylvania Uniform Fraudulent Transfer Act (“PUFTA”), 12 Pa.C.S. § 5101, et. seq.  Like the Bankruptcy Code, PUFTA permits recovery for intentional or actual fraudulent transfers – transfers made with “actual intent to hinder, delay or defraud” creditors.  12 Pa.C.S. § 5104(a)(1).

In Holber, the U.S. Bankruptcy Court for the Eastern District of Pennsylvania considered whether 13 transfers between the Debtor and an entity affiliated with the debtor’s sole member totaling approximately $1.8 million constituted intentional fraudulent transfers.  However, during the same time frame, the debtor received approximately $1.8 million from the same entity.  Holber at 30.

Section 550 of the Bankruptcy Code allows a transfer avoidable under Section 544 to be recovered “for the benefit of the estate.”  11 U.S.C. § 550(a).  The Court explained that Section 550 is remedial and not penal and “the bankruptcy court may reduce or eliminate a trustee’s recovery under §550 where some or all of the transferred property was returned to the debtor pre-petition.”  Id. at 35.

Here, the court applied an “equitable credit” for the money returned to Incare because the Court could not identify how the creditor body was harmed by the transfers that were reversed within the year and to allow the trustee to recover the returned funds would result in a windfall to the estate.  Id. (citing In re Kingsley, 518 F.3d 874, 877-78 (11th. Cir. 2008)).

As the Court recognized, this ruling creates the possibility that a party can avoid the consequences of an intentional fraudulent transfer by simply returning the funds or reversing the transaction.  Holber at 31.  It will be interesting to see if other courts follow suit.

The United States Supreme Court recently issued a ruling in which it held that the Bankruptcy Code’s safe harbor provision § 546(e) does not prevent a trustee from clawing back transfers involving securities and financial institutions in circumstances when such institutions serve as mere pass-through entities for the transfer.  The decision, Merit Management Group, LP v. FTI Consulting, Inc., Case No. 16-784, affirming the Seventh Circuit Court of Appeals, marked a resolution of a circuit split on an issue that will have significant impact in the bankruptcy world.

Lighthouse next to a harbor at sunset

The case involved the sale of stockholder interests by transferor, Merit Management Group, LP, to transferee, Valley View Downs.  Two financial institutions, Credit Suisse and Citizens Bank, were party to the transaction as lender and escrow agent.

The safe harbor defense to the trustee’s avoidance powers exempts transfers that are settlement payments “made by or to (or for the benefit of) a…financial institution.”  The Supreme Court reasoned that the relevant question in determining whether the safe harbor defense applies is the “overarching transfer” the trustee seeks to avoid.  Because the trustee sought to avoid the purchase of stock by Valley View from Merit Management, Credit Suisse and Citizens Bank’s role as conduits, or “component parts” as described by the Supreme Court, were irrelevant to the § 546(e) analysis.  The parties did not contend that either Valley View or Merit Management were covered entities under § 546(e) and accordingly, the transfer was not protected by the safe harbor defense.

The decision throws out previous law made by the Second, Third, Sixth, Eighth and Tenth Circuits on the safe harbor rule and will have significant effects on pending and future bankruptcy proceedings, by enlarging trustees’ avoidance power and narrowing a frequently-used defense by transferee defendants.

Official Committees’ of Unsecured Creditors can, and often do, have significant impacts on cases under chapter 11 of the Bankruptcy Code.  Appointed pursuant to Section 1102 of the Bankruptcy Code, creditors’ committees ordinarily consist of creditors holding large claims against the chapter 11 debtor. The Bankruptcy Code (in, for example, Sections 1103 and 1104) provides Committees with a variety of powers and duties.  For examples, the Bankruptcy Code allows creditors’ committees to hire counsel, participate in the plan of reorganization and pursue bankruptcy litigation, including fraudulent transfers and preferential transfers.

Recently, the First Circuit Court of Appeals joined the Second and Third Circuits to find that Unsecured Creditors’ Committees have an “unconditional right to intervene” in bankruptcy adversary proceedings within the meaning of Federal Rule of Civil Procedure 24(a)(1), which applies in Bankruptcy Proceedings under Bankruptcy Rule 7024.  Assured Guar. Corp. v. Fin. Oversight and Mgmt. Bd. For Puerto Rico (In re Fin. Oversight and Mgmt. Bd. For Puerto Rico), 872 F.3d 57 (1st Cir. 2017).

Aerial view of San Juan, Puerto Rico and Caribbean Sea
San Juan, Puerto Rico

In this case, the First Circuit was considering the ability of the Unsecured Creditors Committee appointed in the quasi-bankruptcy proceedings by Financial Oversight and Management Board for the Commonwealth of Puerto Rico (the “Board”) related to the Puerto Rico debt adjustment case.  In these proceedings, large portions of the Bankruptcy Code were incorporated, including the entirety of the Federal Rules of Bankruptcy Procedure. In these quasi-bankruptcy proceedings, the companies that insure certain Puerto Rico bonds initiated an adversary proceeding claiming that the fiscal plan approved by the Board violated the U.S. Constitution, among other things.  Id. at 60.

After the Creditors’ Committee was appointed, it immediately sought to intervene in this action under Bankruptcy Code Section 1109(b), which provides that “(b) A party in interest, including the debtor, the trustee, a creditors’ committee, an equity security  holders’ committee, a creditor, an equity security holder, or any indenture trustee, may raise and may appear and be heard on any issue in a case under this chapter.” 11 U.S.C. 1109(b).

The First Circuit reversed an opinion by the lower Court denying the committees’ motion for leave to intervene, following prior First Circuit precedent.  Here, the First Circuit explained that its prior precedent constituted dicta and explained that “the weight of persuasive authority has shifted considerably. ”  The Court ruled that “the UCC [unsecured creditors committee] was entitled to intervene under §1109(b) and Rule 24(a)(1),” which governs intervention as of right.  Id. at 63.  The Court found that the Committee had an “unconditional right to intervene,” but elaborated that this does not dictate the scope of participation in that proceeding.  Given that the lower court had not ruled on the scope of participation, the Court remanded that issue for further proceedings.

While Creditors’ Committees have seemingly always had substantial leverage to insert themselves in the debtor’s bankruptcy proceedings and make sure that creditors’ views are heard, this ruling provides further support for the robust rights of committees and a platform for their intervention in and pursuit of a variety of bankruptcy litigation matters to maximize recoveries.

In PAH Litigation Trust v. Water Street Healthcare Partners, LP (In re Physiotherapy Holdings, Inc.), Case No. 13-12965 (KG), Adv. No. 15-51238 (KG), 2017 WL 5054308 (Bankr. D. Del. Nov. 1, 2017), the debtor entered into bankruptcy after a leveraged-buyout transaction (“LBO”).  After a plan was confirmed, a resulting litigation trust brought actual and constructive fraudulent transfers against the defendants (seller shareholder in the LBO) seeking $248 million for actual fraud and at least $228 million for constructive fraud – funds that the defendants allegedly took from the debtors in connection with the LBO).

Cash in U.S. $100 bills, indicating litigation damages

The Defendants (seller/shareholder) to the litigation argued that the litigation trust should not be able to recover a windfall by recovering amounts in excess of the unpaid claims in the case.  Id. at *1.  The Litigation Trust claimed that it can “recover the full amount of the fraudulent transfers” because Section 550 of the bankruptcy code allows the trustee to recover “for the benefit of the estate, the property transferred, or, if the court so orders, the value of the transferred property.”  Id. at *4 (quoting 11 U.S.C. 550).  Here, the property transferred to the defendants and the value of it are the same – the millions of dollars sought to be recovered.

The Court considered various cases from other jurisdictions that have held that “Section 550 damages are not capped to permit creditors to receive only the amount of their claims,” noting that the Third Circuit Court of Appeals appeared not to have ruled on this issue.  PAH Litigation Trust, 2017 WL 5054308 at *4, *7(collecting cases).

The Court ultimately agreed with this line of cases because “[w]ere the Court to rule otherwise, it would mean that if Defendants are in fact liable for the fraudulent transfer, they would keep most if not all of the transferred money. The Court cannot countenance such an inequitable result if liability exists.”  Id. at *7.  Given the great quantity of bankruptcy cases filed in Delaware, it will be interesting to see if this holding is followed by other courts in the Third Circuit.

On March 5, 2018, the Supreme Court issued an opinion in U.S. Bank Nat’l Ass’n v. Village at Lakeridge, LLC, which addressed a single question: Whether the Ninth Circuit properly reviewed for clear error (rather than de novo) the Bankruptcy Court’s determination that a certain individual was not qualify as a non-statutory insider.  The Supreme Court held Ninth Circuit applied that appropriate standard of review.

While the holding is not particularly interesting, the two concurring opinions raise questions as to how bankruptcy courts evaluate whether a person qualifies as a non-statutory insider under the Bankruptcy Code.  Specifically, the concurrences made clear that they were not endorsing the Ninth Circuit’s test for non-statutory insider status.  Under the Ninth Circuit’s test, a creditor qualifies as a non-statutory insider only if it meets two criteria: “(1) the closeness of its relationship with the debtor is comparable to that of the enumerated insider classifications in § 101(31), and (2) the relevant transaction is negotiated at less than arm’s length.”  In re Village at Lakeridge, LLC, 814 F.3d 993, 1001 (9th Cir. 2016) (citation omitted).

In his concurring opinion, Justice Kennedy emphasized that the Court was not endorsing the Ninth Circuit’s test.  He encouraged “courts of appeals … [to] continue to elaborate in more detail the legal standards that will govern whether a person or entity is a non-statutory insider under the Bankruptcy Code,” and to specially consider the relevance and meaning of “arms-length transaction” in the bankruptcy context.

Justice Sotomayor also issued a concurrence (joined by Justices Kennedy, Thomas, and Gorsuch), in which she raised concerns with respect to the Ninth Circuit’s two-prong test.

She suggested two approaches that would be consistent with the understanding that insider status inherently presumes that transactions are not conducted at arm’s length.  The first approach is to focus solely on a comparison between the characteristics of the alleged non-statutory insider and the statutory insiders to see whether they share sufficient commonalities. The second approach might focus on a broader comparison that includes consideration of the circumstances surrounding any relevant transaction.

The New York Law Journal recently published an article on the growing trend of third-party litigation funding in bankruptcy litigation.

Often when there is no cash available under a plan, unsecured creditors are assigned the rights of the debtor to bring avoidance actions and other litigation claims against third parties. These claims have the potential to yield significant value, but only when there are resources available to prosecute the claims. Litigation funding is a tool for maximizing the value of a bankruptcy estate’s litigation claims when the estate itself lacks the resources to pursue the claims and traditional sources of financing are not available.

The article offers an overview of commercial litigation funding in the bankruptcy context.  For more detail, visit the New York Law Journal’s website. (subscription required).

The Bankruptcy Court for the Southern District of Florida recently held that a chapter 7 trustee is not bound by a debtor’s pre-bankruptcy waiver of its jury rights for fraudulent transfer claims brought by the trustee under Section 548 of the Bankruptcy Code.  In Bakst v. Bank Leumi, USA (In re DIT, Inc.), 575 B.R. 534 (Bankr. S.D. Fla. 2017), the chapter 7 trustee sued to recover alleged fraudulent transfers related to certain payments by a corporate debtor to its lender and included a jury demand.  The lender moved to strike the trustee’s jury trial demand, claiming that the debtor had waived the right to a jury in certain contracts entered by the debtor before it filed for bankruptcy.

Court Pillars
Copyright: bbourdages / 123RF Stock Photo

The Bankruptcy Court for the Southern District of Florida considered a variety of arguments made by the lender but ultimately found that the even if the face of a pre-petition contractual jury waiver by the debtor, the trustee still retained the right to a jury.  The Court explained that there is an important distinction between litigation claims “owned by the debtor prior to the bankruptcy and that became property of the estate under section 541” of the Bankruptcy Code and litigation claims “that may only be brought by the estate under the avoidance provisions of the Bankruptcy Code, such as the fraudulent transfer claims presented here under section 548” of the Bankruptcy Code.  Id. at 536.

Under Section 541 of the Bankruptcy Code, the bankruptcy estate created by the filing of bankruptcy includes “all legal and equitable interests of the debtor in property as of the commencement of the case.”  11 U.S.C. § 541(a)(1).  These pre-existing litigation claims owned by the debtor under Section 541 are subject to all the defenses that would have otherwise been available pre-petition.  Bakst, 575 B.R. at 536.  However, for claims created by the Bankruptcy Code – such as fraudulent transfer avoidance actions – the Bankruptcy Court for the Southern District of Florida held that the trustee is not bound by the debtor’s contractual jury waiver that occurred prior to bankruptcy.  Id.

This may also arise with respect to agreements to arbitrate, for which the Court explained that “a debtor’s pre-bankruptcy agreement to arbitrate disputes with a particular creditor is binding on the estate with regard to claims held by the debtor that are later pursued by the estate representative, as such claims become part of the estate under section 541.  But, the estate is not bound by a debtor’s pre-bankruptcy arbitration agreement when the estate seeks relief under the Bankruptcy Code itself.”  Id. (citing Hays & Co. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 885 F.2d 1149, 1155 (3d Cir. 1989), among other cases).