WurstCaseScenario

Last week, the Second Circuit Court of Appeals issued a significant decision regarding the General Motors bankruptcy.  You probably remember an earlier case, where the Second Circuit reversed the bankruptcy court’s determination that JPMorgan Chase and its syndicate could remain as a secured party despite having erroneously filed a UCC Termination Statement.  Last week’s decision is another blow to a significant bankruptcy court determination.  In its decision, the bankruptcy court found “new GM” to be clear from claims arising out of defective ignition switches, even though the claims were known or reasonably ascertainable by “old GM” prior to its sale of assets to “new GM,” and yet, “old GM” did not provide those plaintiffs and potential plaintiffs with notice of the bankruptcy sale.

The bankruptcy court ruled that the plaintiffs were not provided with notice as required by procedural due process, even though “old GM knew or with reasonable due diligence should have known of the[ir] . . . claims.”  Although publication notice was issued and parties are presumed to have received such notice, publication notice does not assure that claimants or potential claimants actually received notice.

Nonetheless, the bankruptcy court concluded that failure to give notice did not entitle plaintiffs to pursue their claims against new GM because even if they had received notice and objected, the bankruptcy court determined that it would have overruled the objection and approved the 363 Sale as it was.  The Second Circuit reversed that thinking.

The Second Circuit focused on the plaintiffs’ rights under the “due process clause” of the Fifth Amendment of the United States Constitution providing that:  “No person shall . . . be deprived of life, liberty, or property, without due process of law.”  This is one of the most fundamental rights afforded under our Constitution.

The Second Circuit maintained that the bankruptcy court erred by concluding that the lack of notice was inconsequential because any legal argument the plaintiffs would have brought would have failed, resulting in the approval of the 363 sale.  Taking in the entirety of the business circumstances and the lost opportunity to negotiate, the Second Circuit concluded that due process is not limited to the opportunity to make a legal argument. Rather, it is the opportunity to participate in the proceedings in a meaningful way.

Although the Federal Judge overseeing the product liability cases dismissed many of them by the end of last week, many remain, and there is the potential for “new GM” to become burdened with obligations it had not intended to assume as part of its “purchase.”

So what does this mean to us?  It certainly means that when we are funding a purchaser of assets in a 363 Sale we want to be assured that all creditors, potential creditors, and potential claimants have received fair notice so as to entitle them to due process.  That is a pretty tough standard because the lender only knows what it knows, and even in this situation, would not have known what GM knew – that there was a defective ignition switch that was causing accidents and deaths and that owners of GM vehicles would likely be asserting those claims.

This is a dilemma that lenders will need to focus on in financing acquisitions of assets under § 363.  Stay tuned, I suspect we will be discussing this in future blogs.

When I started my blog I assured our readers that I would continue to publish scheduled articles as I have over the years.   Of course, the purpose of the blog is to bring you up to date discussions on issues as they arise while often publication dates for articles are scheduled months in advance.  As it happens, a topic that was scheduled months in advance and is currently appearing in the ABF Journal, has picked up some steam – at least on a matter in which I am presently involved.   In my current matter, a security agreement provided a granting clause that granted to the secured party a security interest in “all assets.”   This conveniently has merged a current published article scheduled months in advance with a current issue (at least in my world).   Click here to see the article:  http://bit.ly/28x9AO9

 

A costly education.

The crisis in the oil and gas industry has provided considerable work for insolvency attorneys.  Several decisions in a case in the Western District of Washington State just came down and should be of interest to our readers.  One of these cases again addresses the perils that arise when a consignor fails to perfect its interest in goods delivered to a consignee.   In re: Pettit Oil Company began as a Chapter 11 but was subsequently converted to a Chapter 7 and the trustee brought an avoidance action against IPC (USA) Inc., a seller of fuel to Pettit Oil.

The pre-petition debtor and IPC had entered into a consignment agreement whereby IPC delivered fuel to the debtor’s terminals to be sold to its transportation customers.  The consigned fuel was not identified as such but the invoices for consigned fuel sold directed account debtors to make payments to an IPC lockbox.  To complicate matters, in addition to consigning fuel to the debtor it also sold fuel (as did other suppliers) that was not subject to the consigned agreement.   Invoices for non-consigned fuel directed account debtors to make their payments to a lockbox at Key Bank, the debtor’s secured lender.  Any customer might be purchasing both consigned and non-consigned fuel.  As a result customers often paid the Key Bank lockbox when it should have paid the IPC lockbox.  The consignment arrangement continued from the pre-petition period to the post petition period.

When Pettit commenced its Chapter 11 case it sought use of cash collateral.  Although the first interim order granting use of cash collateral did not address the IPC consigned fuel, subsequent interim orders did.  The second interim cash collateral order provided that any “amounts belonging to IPC” be sent to IPC not later than two banking days after deposit in the Key Bank cash collateral account, unless an objection was filed.  The third interim cash collateral order provided that the “amount of the Cash Collateral to be used by Debtor in its operations shall not include any amount in the Cash Collateral Account at KeyBank or in the Third Party Banks consisting of funds belonging to IPC.”  During this period the court also issued a First Supplier Order which authorized the debtor to purchase supplies from certain vendors.  IPC was included as a supplier.

During the three week period immediately following the petition date, there were six transfers from the Debtor’s KeyBank accounts to IPC whereby IPC received over $8 million from the debtor’s fuel sales. Three weeks into the Chapter 11 case, there was in excess of $1 million in inventory in the debtor’s fuel tanks that continued to generate accounts receivable. The accounts receivable generated from this inventory were either (1) paid by customers directly to the IPC Lockbox, (2) paid by customers to the KeyBank Lockbox and remitted to IPC, or (3) paid to the KeyBank Lockbox and retained by KeyBank.  The trustee brought an avoidance action against IPC to recover the post-petition transfers.

The court stated: “Pursuant to § 549, the Trustee may only avoid post-petition transfers of ‘property of the estate.’ IPC argues that the Trustee cannot avoid the post-petition transfers pursuant to § 549 because the sale proceeds of the petroleum products never became property of the estate.  Property of the estate is defined as ‘all legal or equitable interests of the debtor in property as of the commencement of the case.’ [Bankruptcy Code] Section 541(a)(1). The existence and nature of a debtor’s interest in property is determined by non-bankruptcy law.”

The court then focused on UCC §§ 9-102(20) (the definition of Consignment) and 9-319(a) and the impact of IPC’s failure to perfect.  It expressed concerns over IPC’s failure to perfect and whether IPC was a supplier or a consignor that neglected to perfect.  To the extent IPC was a supplier, it would be entitled to be paid for its post-petition sales of fuel.  The concern was how to treat the post-petition payments if IPC was a post-petition unsecured consignor.

“The Trustee does not disagree that title to the fuel inventory remained with IPC post-petition.  It is undisputed that the Consignment Agreement provides that title to inventory and proceeds remains with IPC.  As between the Debtor and IPC, therefore, IPC retained title to and ownership of the inventory and proceeds, even after the Debtor filed bankruptcy, and even though IPC failed to properly perfect its interest.  The Trustee, however, argues that title and ownership are irrelevant to the analysis of whether such inventory, and proceeds that flowed from such inventory, became property of the estate.”

The court did not determine IPC’s fate as an unperfected post-petition consignor and denied the motion for summary judgment:  “The answer may be that the analysis will be the same for property delivered as of the petition date or post-petition by virtue of § 541(a)(7), but neither party has provided sufficient analysis or authority for the Court to render a decision on this issue at this time. The issue in this case may be further complicated by the fact that the product was delivered post-petition pursuant to a prepetition agreement.”

Whether IPC ultimately prevails is inconsequential.  The cost of litigating the issue could have easily been avoided if it had been more knowledgeable concerning the consignments it intended.  As we indicated in our earlier blog, consignments remain a viable method to effect sales but consignors (and their lenders) must assure that the process for perfection is properly followed lest they be subject to a costly education.

The US Supreme Court issued a decision today on a significant case that has been followed by bankruptcy practitioners.  The case relates to whether a judgment for fraudulent conveyance may be discharged.  The Court wrote:

“The Bankruptcy Code prohibits debtors from discharging debts ‘obtained by . . . false pretenses, a false representation, or actual fraud.’ 11 U.S.C. § 523(a)(2)(A).  The Fifth Circuit held that a debt is ‘obtained by . . . actual fraud’ only if the debtor’s fraud involves a false representation to a creditor.  That ruling deepened an existing split among the Circuits over whether ‘actual fraud’ requires a false representation or whether it encompasses other traditional forms of fraud that can be accomplished without a false representation, such as a fraudulent conveyance of property made to evade payment to creditors.  We granted certiorari to resolve that split and now reverse.”

The underlying case involved facts familiar to many lenders.  Daniel Lee Ritz, a director and shareholder of Chrysalis Manufacturing Corp., made transfers to entities in which he had ownership interests draining Chrysalis of assets while it was indebted to Huskey International Electronics, Inc., the plaintiff.  After Husky commenced a lawsuit against him, Ritz filed a Chapter 7.  Husky brought an adversarial proceeding against Ritz claiming the transfers to be “actual fraud” and to bar his discharge.  The District Court held that Ritz was personally liable but that the debt was not “obtained by . . . actual fraud” under § 523(a)(2)A).  The Fifth Circuit Court of Appeals recognized that in transferring Chrysalis’ assets, Ritz may have hindered Husky’s ability to recover its debt, but found that he did not make any false representations to Husky and therefore did not commit “actual fraud.”

The Court noted that the historical meaning of “actual fraud” provides strong evidence that the phrase has long encompassed the kind of conduct alleged to have occurred here:  a transfer scheme designed to hinder the collection of debt.

“‘Actual fraud’ has two parts:  actual and fraud.  The word ‘actual’ has a simple meaning in the context of common-law fraud:  It denotes any fraud that ‘involv[es] moral turpitude or intentional wrong.’ . . . ‘Actual’ fraud stands in contrast to ‘implied’ fraud or fraud ‘in law,’ which describe acts of deception that ‘may exist without the imputation of bad faith or immorality.’ . . . Thus, anything that counts as ‘fraud’ and is done with wrongful intent is ‘actual fraud.'”

Seven of the sitting judges joined in this decision written by Justice Sotomayor with (as you might expect) Justice Thomas as the sole dissenter, writing “The majority today departs from the plain language of § 523(a)(2)(A), as interpreted by our precedents.”

Notwithstanding, the Court held that it must give the phrase “actual fraud” in § 523(a)(2)(A) the meaning it has long held, and interpreted the term “actual fraud” to encompass fraudulent conveyance schemes, even when those schemes do not involve a false representation.

May 16, 2016

Husky Interntional (Actual Fraud) SCOTUS decision