Code Statutory Interpretation

Subscribe to Code Statutory Interpretation via RSS

With classic reorganizations a relic of the past, and retail bankruptcies and distress sales way up, the question of what assets may be sold in a retailer’s 363 auction of its primary business assets early in the case is of paramount importance.  One of Delaware’s newest Bankruptcy Judges, Kevin P. Gross, addressed this issue last week in the Whitehall Jewelers’ bankruptcy case, one day before the bid deadline and ten days before the scheduled August 8th auction.  In re Whitehall Jewelers Holdings, Inc., 2008 WL 2951974 (Bankr. D. Del. 7/28/08) (pdf).  The Deal’s Jamie Mason provided this background to the auction:

A Delaware judge has approved the bidding procedures for bankrupt jewelry retailer Whitehall Jewelers Holdings Inc.’s going-out-of-business sales at all of its stores but not the stalking-horse bidder’s breakup fee. Since the breakup fee was denied, the group has reserved the right not to participate in the auction, so it’s unclear if there will be a stalking-horse bidder for the sale. The stalking-horse bidders had agreed to pay Whitehall, which sells diamonds, gold, precious and semiprecious jewelry and watches, 55.5% of the value of the inventory if it’s between $169 million and $177 million. However, if the inventory is worth between $138 million and $145 million, Whitehall will receive 53.5% of the value. This means that Whitehall could receive between $73.8 million and $98.2 million, depending on what its inventory is worth.

With much riding on the value of the inventory, Judge Gross was asked to determine whether it is permissible under Code section 363(f)(4) to sell approximately $63 million of consigned goods in inventory from Whitehall’s 373 retail stores in a 363 sale?  The consigned goods weren’t segregated at the stores, and the vendors themselves split into two general groups: 

  • Those who failed to file financing statements and those who filed improperly or who failed to comply with UCC Article 9, including those who did not refile when Debtors changed their name (too conveniently so, charged these consignment vendors) from "Whitehall Jewellers" to "Whitehall Jewelers"; and
  • Those whose consignments are governed by UCC Article 2 and therefore are subject to the claims of Debtors’ creditors.

Section 363(f)(4) was implicated because the Debtors argued that the consignment vendors’ interests in the consigned goods is in bona fide dispute within the meaning of Section 363(f)(4), which permits assets sales free and clear of any third party interest in the property only if such interest "is in bona fide dispute." 

After reviewing various cases within and outside the district, Judge Gross concluded that no sale of the consigned inventory was permitted under Code section 363(f)(4) "without first demonstrating to this Court that the consigned goods are property of the estate." Judge Gross, however, would only resolve that issue by way of a full-blown adversary proceeding and not through a contested sale motion under Section 363. While recognizing the burden on Whitehall from having to initiate over 120 adversary proceedings (i.e, complaints) in the short time available before the sale, Judge Gross concluded that he had no choice in the matter, stating:

Continue Reading Delaware’s Judge Kevin Gross Rules That, Absent Adequate Protection, Whitehall’s Asset Sale May Not Include Consigned Jewels

Last year, then "Junior Scholar" — and now Associate Professor of Law at Georgetown — Adam Levitin (who is also a long-time reader of this blog!) wrote an excellent piece entitled Finding Nemo: Rediscovering the Virtues of Negotiability in the Wake of Enron, 2007 Colum. Bus. L. Rev. 83 (WL) / (pdf).  In it, he strongly criticized a decision by Bankruptcy Judge Arthur Gonzalez denying a good faith bankruptcy claim purchaser’s motion to dismiss the Enron estate’s cause of action for equitable subordination based not on the purchaser’s own misconduct, but on the conduct of previous owners of the claims purchased, regardless of whether the conduct related to the claims themselves.  Enron Corp. v. Springfield Assocs., L.L.C. (In re Enron), 2005 WL 3873893 (Bankr. S.D.N.Y.  11/28/05) (pdf).  Professor Levitin sums up his critique of Judge Gonzalez’s ruling as follows (at pp. 90-91):

The problems in Enron speak to a fundamental commercial law question about choice of property transfer rules.  Enron was based on the commercial law principle of nemo dat quod non habet — you can only transfer what you have.  Nemo dat means that defenses travel with property transfers, so if bankruptcy claims would be subject to equitable subordination in the hands of a transferor, they should remain so in the hands of a transferee.

Nemo dat is the default rule for property transfers, but there is a competing commercial law paradigm: negotiability [as in Articles 2, 3, 7, and 8 of the UCC], and the law of real estate mortgages and titles.  The essential characteristic of negotiability is that only limited defenses travel with property, and thus a transferee can receive more than the transferor had–a property right free of certain defenses against its enforcement.  This means that there is some level of negotiability in any area of law with a good faith purchaser defense…. 

Historically, the law has differentiated between whether it adopts a nemo dat regime or a negotiability regime based on whether transactions are commercial or consumer….  [T]his article argues in favor of applying a negotiability regime to bankruptcy claims trading and proposes a general reconsideration of the rules governing the defenses that travel with a property transfer in commercial contexts.

Last January, District Court Judge Shira A. Scheindlin (herself no stranger to high-stakes bankruptcy controversies) granted the disheartened claims purchasers’ request for leave to file an interlocutory appeal of Judge Gonzalez’s ruling.  She also concurrently granted the request filed in connection with an analogous interlocutory ruling by Judge Gonzalez in Enron Corp. v. Avenue Special Situations Fund II, LP (In re Enron), 340 B.R. 180 (Bankr. S.D.N.Y. 2006) (pdf), in which he disallowed under Code section 502(d) the claim of an entity that purchased its claim from a party who had received a potentially avoidable prepetition transfer.  Judge Scheindlin granted these interlocutory appeals, she said, so that she could consider the following question that "although fairly simply stated, is complex and of first impression in this Circuit, and will have serious ramifications well beyond the parties involved in this particular appeal":

Whether equitable subordination under 510(c) and disallowance under 502(d) can be applied, as a matter of law, to claims held by a transferee to the same extent they would be applied to the claims if they were still held by the transferor based on alleged acts or omissions on the part of the transferor.

Last week, Judge Scheindlin was again the toast of distressed debt industry based on her lengthy decision vacating Judge Gonzalez’s decisions.  See Springfield Assocs., L.L.C. v. Enron Corp. (In re Enron), 2007 WL 2446498 (S.D.N.Y. 8/27/07) (pdf).  Though Judge Scheindlin never cites to Professor Levitin’s article, she does note — as does Professor Levitin — that the central distinction to be made in analyzing the question presented is whether the "well-established doctrine of nemo dat qui non habet" applies.  (Op. at 20-22.) 

To Judge Scheindlin, if the claims are being asserted by good faith purchasers of bankruptcy debt, then the doctrine doesn’t apply and the claims cannot be equitably subordinated under Code section 510(c) or disallowed (pending receipt of the avoidable transfer) under Code section 502(d).  Conversely, Judge Scheindlin ruled, if the transferee obtained the claim by way of "assignment," then the nemo dat doctrine applies, the "personal disabilities" of the claimant "travel with the claim," and the assignee’s claim is subject to possible subordination and disallowance.  (Op. at 29-44.)

Notably, Judge Scheindlin emphasizes, her decision is not based on policy concerns, and in particular the impact that an affirmance would surely have on depressing values in an already depressed market for distressed debt.  See, e.g., Levitin Article at 161-164 ("Developments in the Refco bankruptcy provide an early look at … how seriously Enron has affected the claims trading market….  As soon as rumors surfaced of BAWAG’s alleged misdeeds, all claims that had ever passed through BAWAG’s hands became radioactive before the other Refco creditors filed suit against BAWAG.  No one would purchase them for any price because of the fear of subordination or disallowance.")  Still, she seemed relieved to be able to note not only that "[t]he unnecessary breadth of the Bankruptcy Court’s decisions threatened to wreak havoc on the markets for distressed debt," but also that, with this decision, "[t]hat result has now been avoided."  (Op. at 52.)

What then was the basis for Judge Scheindlin’s reversal? 

© Steve Jakubowski 2007Continue Reading Nemo Filleted: Judge Scheindlin Rules that Good Faith Purchasers of Claims in Bankruptcy Need No Longer Choke on the Personal Disabilities of the Claims Transferor

UAL’s proposed plan of reorganization provides for a modicum of distributions on the plan effective date of UAL’s plan to unionized employees, as required by the terms of revised collective bargaining agreements. UAL, relying upon Bankruptcy Code section 505(a) (which allows the bankruptcy court to “determine the amount or legality of any tax”), sought a declaratory ruling from the bankruptcy court that distributions to employees under the plan cannot be taxed by the IRS as “wages.” This issue is quite significant to UAL because a favorable ruling would save UAL tens of millions of dollars in federal withholding taxes and the like that would have to be paid were the distributions to be characterized as “wages” for federal tax purposes.
The UAL bankruptcy court, however, refused to even reach the merits because it concluded (opinion available here) that it lacked jurisdiction to decide the tax effects of a Chapter 11 plan before it has been confirmed.
In so doing, the Court noted the paucity of cases and consensus on “when a tax issue must arise in order to be subject to adjudication” as compared with “whose tax issues may be adjudicated under looked at the language of Code § 505(a).” The Court stated:Continue Reading UAL Bankruptcy Court Looks to Context of Specific Code Chapter in Refusing to Exercise Jurisdiction Over Question of Whether Plan Distributions on Union Employee Claims are Taxable as “Wages”