Will Soper writes: 

On May 29, the United State Bankruptcy Court for the Northern District of Illinois ruled on several discovery motions between disputed owners of an unsecured claim in a bankruptcy action.  See In re: Caesars Entertainment Operating Co., Inc., No. 15-1145 (Bankr. N.D. Ill. May 29, 2018).  The case serves as a reminder that bankruptcy litigation matters are subject to the Federal Rules of Civil Procedure and objections to discovery must be specific enough to avoid waivers of the objections for lack of specificity.

Document ProductionThe dispute centers around whether or not Earl of Sandwich (“Earl”) sold its $3.6 million claim against Caesars to Whitebox Advisors, LLC (“Whitebox”). Pursuant to the Federal Rules of Bankruptcy Procedure, the hearing to determine the true holder of the claim included a discovery process which incorporates Federal Rules of Civil Procedure 26, 30, 34, and 37.  Both parties filed motions objecting to document requests.

The court took a hard line against “rote or boilerplate” objections to document requests and found that where Whitebox simply stated that requests were “overbroad” or “unduly burdensome” without specificity or reasons given, the objections were insufficient and resulted in waivers.  Id. at 6-7.

Similarly, the court found that objections must be raised by a party in its Response to a Request for Production of Documents, not in discussions with the opposing party or other pleadings. Whitebox failed to properly assert its objections on the grounds of relevance, raising them for the first time in its Response to Earl’s Motion to Compel and asserting they were discussed in conference. As such, the court deemed these objections waived as well.  The Court also found that failure to serve a privilege log amounts to “non-assertion of the privilege” and constitutes yet another waiver.  Id. at 9-10.

Will Soper is a Summer Associate in Fox Rothschild’s Denver, Colorado Office.

Yesterday a panel of the U.S. Court of Appeals for the Ninth Circuit issued an opinion reversing a district court order dismissing an appeal from the bankruptcy court for lack of standing.  See Harkey v. Grobstein (In re Point Center Financial, Inc.), Bankr. No. 16-56321, D.C. No. 8:16-cv-1336-DSF (May 29, 2018, 9th Cir.).

The appeal was related to the U.S. Bankruptcy Court for the Central District of California’s order authorizing a chapter 7 trustee to assume the operating agreement of a limited liability company whose interests were implicated in the bankruptcy proceedings.

On appeal, the U.S. District Court for the Central District of California found that the members and president of the LLC lacked standing to challenge the Bankruptcy Court order because, despite receiving notice of the trustee’s assumption motion, they did not object or attend the hearing on the motion.  The Ninth Circuit explained that standing to appeal a bankruptcy court order is limited to “persons aggrieved” by the order.  Id. at 7 (collecting cases).

A person aggrieved is someone “‘directly and adversely affected pecuniarily’ by a bankruptcy court’s order.”  Id. (citing Fondiller v. Robertson (In re Fondiller), 707 F.2d 441, 443 (9th Cir. 1983)).  This can include an order “that diminishes one’s property, increases one’s burdens, or detrimentally affects one’s rights….”  Id. (citation omitted).  The Court explained that this standard exists because Bankruptcy Court orders can implicate the interests of various stakeholders, including entities and individuals who are not formally parties to proceedings.

In reversing the District Court opinion, the Ninth Circuit considered whether attendance at the hearing and filing an objection are “prerequisites” to appellate standing under the person aggrieved standard and found that “[b]ankruptcy standing concerns whether an individual or entity is ‘aggrieved,’ not whether one makes that known to the bankruptcy court.”  Id. at 10.  Thus, the Ninth Circuit concluded that an appellant need not attend the hearing or file objections to be adversely affected by a bankruptcy court decision and have standing to appeal.  Id. (reversing and remanding).

Anahita Anvari writes:

In In re Beach v. Beach, the Fifth Circuit elaborated on its standard of review for adversary litigation settlements.  No. 17-10481 (5th Cir. May 16, 2018).

In this case, Debtor, a Dallas oil-and-gas businessman, formed a partnership to drill oil with a New York investment firm (“Creditor”).  Following a dispute between Debtor and Creditor, Debtor filed for bankruptcy.

Creditor and Trustee filed an adversary proceeding against Debtor, claiming he was not entitled to a discharge of his debts under Section 727 of the Bankruptcy Code. The Complaint alleged that Debtor fraudulently transferred assets from a family trust to a new trust to shield the assets from creditors. Section 727 prevents discharge of the debtor where the debtor has fraudulently transferred assets to hinder, delay, or defraud creditor or officer of the estate. 11 U.S.C. § 727(a)(2).

In mediation, Trustee reached an agreement with Debtor (the “Settlement”) while representatives of Creditor were not present.  Creditor objected to the Settlement, arguing that it did not maximize value for the creditors.  After a two-day hearing, the bankruptcy court approved the settlement.  Creditor appealed to the district court, which affirmed.

The bankruptcy court weighed the overall costs and benefits of the exchange, reasoning that Trustee would likely win the precise settlement amount in litigation, and that litigation would be complex and costly. As to Creditor’s argument that the Settlement did not maximize the value of one of Debtor’s assets, the bankruptcy court reasoned that the value was merely speculative and did not render the Settlement unfair.

The Fifth Circuit reviewed the bankruptcy court’s approval of the Settlement for any abuse of discretion. The Court held that “a trial court abuses its discretion when it makes an error of law or clearly erroneous assessment of evidence.”  The Court found that the bankruptcy court made findings showing its consideration of the three-part balancing test to determine if the Settlement is in the best interest of the estate. Specifically, the bankruptcy court considered: (1) the probability of success in litigation of the adversary claim; (2) the complexity and likely duration of litigation; and (3) other factors including (i) the best interest of the creditors and (ii) the extent to which the settlement is a product of bargaining, and not fraud or collusion.

The Fifth Circuit affirmed the findings of the lower courts.  In so ruling, the Court considered the evidence provided by Creditor, including costs and likely outcome of litigation. The Court reasoned that the bankruptcy court adequately considered the three-part test, and did not abuse its discretion or make any legal errors or clearly erroneous factual findings or assessments of the evidence.

Anahita Anvari is a summer associate in the firm’s Philadelphia office.

David Doty writes:

The U.S. Bankruptcy Court for the Northern District of California recently held that a Hong Kong resident who had made online purchases of wine through a California retailer was subject to personal jurisdiction. See Kasolas v. Yau, Adv. Pr. No. 18-04012 (N.D. Cal. Bankr. May 11, 2018).

The defendant, a Hong Kong resident, had been a frequent customer of the debtor’s California wine-retail business, which made wine shipments to Hong Kong upon the defendant’s request. Though the defendant maintained an active business relationship with the wine-retailer, most of his interactions were conducted online while he was physically present in Hong Kong.

The bankruptcy trustee commenced an adversary proceeding against the defendant for recovery of fraudulent transfers. In response, the defendant moved to dismiss for lack of personal jurisdiction, arguing that he had not purposefully availed himself to the fora of the United States or California because he had never been physically present in either when these transactions took place.

The hallmark guidance for determining personal jurisdiction was expressed in Burger King Corp. v. Rudzewicz, in which the Supreme Court held that the exercise of specific personal jurisdiction over a nonresident defendant is proper if the defendant purposefully directed his activities at the forum, and the litigation results from injuries arising out of those activities. 471 U.S. 462, 472-73 (1985).

The bankruptcy court addressed the defendant’s argument by applying the Ninth Circuit’s three-part test for personal jurisdiction over a nonresident defendant, which considers factors relating to (1) personal availment, (2) relational proximity between the activities and the underlying claim, and (3) the reasonableness of jurisdiction if exercised. Though the bankruptcy court ultimately found all three prongs to be satisfied, it is the bankruptcy court’s discussion and treatment of purposeful availment that merits particular attention for its implications on an ever-growing online market.

Although there was evidence suggesting that defendant had made in-person purchases in California on at least one occasion, the bankruptcy court found his online contacts with the wine-retailer to be sufficient in and of themselves for purposes of asserting personal jurisdiction. First, relying, in part, on Burger King, the bankruptcy court reiterated that physical presence in a forum is not a necessary prerequisite for a court in that forum to assert personal jurisdiction over a nonresident defendant. Second, the bankruptcy court attached significant weight to the notice the defendant had of his activities being directed toward California and, by extension, the United States. The bankruptcy court determined that the defendant not only had personal knowledge of the wine-retailer’s location being in California, but that his knowledge was further bolstered by the terms and conditions on the wine-retailer’s website which indicated that it was indeed a California company.

Here, the bankruptcy court extended personal jurisdiction across borders in an increasingly internationalized online market made possible by technological advances – progress that the bankruptcy court opined only “strengthens the underlying rationale” of Burger King and its jurisprudential lineage. While the practical implications of this decision can be easily imagined, this case nevertheless demonstrates one of many ways in which the law continues to adapt to growing commerce.

David Doty is a summer associate in the firm’s Philadelphia office.

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.