This case should sufficiently concern private equity investors who extend secured credit, appoint a board member, are granted an option to purchase the business, and then foreclose and take over the business when the debtor–predictably–defaults.

In this 12/8/17 decision (In re Comprehensive Power, Inc., 2017 WL 6327192, Bankr. D. Mass), Judge Panos notes that the lender (“Moog”) moved to dismiss the Chapter 7 Trustee’s recharacterization / fraudulent transfer complaint because “it is merely a non-insider creditor that extended a loan to the Debtor after the parties executed financing documents memorializing the transaction, which included a security agreement granting Moog a security interest in substantially all assets of the Debtor.”

All Moog did, it argued, was enforce its rights as a secured creditor post-default under the transaction documents by accepting surrender of the collateral through a strict foreclosure and then credit bidding about 1/3 of its $6 million loan at a UCC sale. And sure, its board designee was funneling confidential information, but don’t private equity lenders always designate a board member precisely to ensure they get confidential information given the amount of the lender’s capital that is at risk? What’s wrong with that?

Well, Judge Panos found enough wrong with it to sustain all of the Trustee’s counts against the lender except for equitable subordination.  He sustained the Trustee’s recharacterization count because 6 of 11 AutoStyle factors were present, stating:

Here, drawing reasonable inferences in his favor, the Trustee has pleaded sufficient facts in support of at least six of the recharacterization factors, sufficiently stating a plausible claim for recharacterization of Moog’s debt. While the Trustee admits that the names given to the documents align with traditional naming constructs for financial instruments, he argues that, overall, there were components of the transaction that revealed its true nature to be equity rather than debt. With respect to the recharacterization factors, the Trustee points to allegations relating to the presence or absence of a fixed maturity date and schedule of payments and the presence or absence of a fixed rate of interest and interest payments to support his contention that the terms of the instruments and circumstances of the transaction were “atypical.”

Specifically, the Trustee alleges: (i) Moog’s standard practice was to engage in acquisitions, not provide loans, thereby indicating that Moog was implementing a unique “loan-to-own” transaction rather than establishing a true lender-borrower relationship; (ii) monthly interest payments were outside of the norm; (iii) the Debtor could extend maturity if the option was not exercised by Moog in connection with the Option Agreement; and (iv) Moog obtained substantive rights in the context of the transaction which are not typically given to traditional lenders, such as the right to appoint a representative to the Debtor’s Board and an option to acquire the Debtor’s assets or stock. Compl. ¶¶ 24–26, 50.

With respect to the source of repayments, the Trustee alleges that parties contemplated that the Moog financing could be repaid through Moog’s acquisition of the Debtor’s assets or stock, which could potentially support a claim for recharacterization. Id. Exs. A–B. As to the adequacy or inadequacy of capitalization, the Trustee alleges that the Debtor was undercapitalized and/or insolvent during relevant times, including at the time of the Surrender Agreement. Id. ¶¶ 32–34. The Trustee supports the allegation that the Debtor was undercapitalized and/or insolvent by further alleging that the Debtor (i) suffered losses in 2012 and 2013 that would have bankrupted the Debtor if it did not receive cash advances; (ii) encountered cash flow problems just months after receiving “advances” from Becana and others; (iii) had “trouble keeping pace with payments owed to employees, vendors and others”; (iv) depleted the $6 million in funding received from Moog in just a few months; and (v) defaulted on obligations to Moog less than ten months after the financing transaction. Id. ¶ 49. Whether evidence supporting these allegations could contradict the Trustee’s theories regarding the value of the Debtor’s business at the time of the transactions with Moog is a consideration that is more appropriately addressed when the record has been developed.

Regarding the Debtor’s ability to obtain financing from outside lending institutions, the Trustee alleges that the Debtor encountered cash flow problems and required further cash only months after receiving $6 million from Moog, suggesting the Debtor would be unlikely to obtain a traditional loan because of its cash flow issues. Id. ¶¶ 49, 51. The Trustee further alleges that no sinking fund was available to the Debtor to provide repayments, which Moog acknowledges, but argues is a “neutral” factor with respect to recharacterization. Mot. ¶ 61.

In sum, taken together, the factual allegations and the inferences drawn in favor of the Trustee are sufficient to state a plausible recharacterization claim.

In sustaining the actual fraudulent transfer claims against the lender, he stated:

The phrase “bad boys” is one that conjures up a multitude of contradictory connotations. In sports, the Detroit Pistons wore the moniker proudly as they pummeled their way to consecutive NBA championships. Those bad boys, however, are long gone and now the same team is just plain bad

In art, Jerry Bruckheimer produced “Bad Boys” in 1995 and “Bad Boys II” in 2003, starring Will Smith and Martin Lawrence as bad boy Miami detectives. These likeable actors, however, failed to convey much of a bad boy image and critics panned the movies. Not deterred, a third installment, “Bad Boys III,” is scheduled for 2015, but it too (like "Die Hard 5") is likely to disappoint.

In life, John Alleman had become a Las Vegas sensation. Starting in about June 2011, he stood outside the Heart Attack Grill for nothing more than the love of the place (and some occasional free food) and colorfully pitched and cajoled people to sample such delicacies as Flatliner Fries, Butterfat Shakes, and the king-of-them-all, the Quadruple Bypass Burger (which holds the Guinness World Record for the “most calorific burger”). Late last year, this bad boy suffered a massive heart attack at a bus stop and died, thus ending his short—but glorious—reign as Sin City’s leading tempter of fate.

In the law, bad boys often find they pay a hefty and quite disproportionate price for their bad acts. Consider, for example, the case of Michael Turner. This bad boy received a $40,000 insurance settlement check three days before he filed bankruptcy and then cashed the check three days after he filed bankruptcy, using about one-quarter of the proceeds to pay down a mortgage while pocketing the rest.  His failure to disclose this asset in his bankruptcy schedules, as mandated by the Code, led a grand jury three years later to return a six-count indictment against him that eventually resulted in a bankruptcy fraud conviction and a 27 month jail sentence.  The 11th Circuit recently upheld his sentence as appropriate under today’s harsh federal sentencing guidelines. United States v. Turner, 2013 WL 510092 (11th Cir., Feb. 12, 2013) (PDF).

Some bad boys, however, manage to avoid the cudgel of the law by seizing onto a loophole that averts near certain doom. Consider, for example, bad boy Bernie Kurlemann, whose bank fraud conviction was reversed because the statute only criminalizes “false statements.”  Since he kept his mouth shut and told only half the truth, the court ruled, he couldn’t be convicted under a statute that does not criminalize “half-truths,” “material omissions,” or “concealments.”   United States v. Kurlemann, 2013 WL 513976 (6th Cir., Feb. 13, 2013) (PDF). True, Kurleman was still convicted on bankruptcy fraud charges, but that paled in comparison to the time he would have served had the bank fraud conviction been upheld.

Finally, consider so-called "bad boy" bank guaranties, where one’s personal liability to a lender is instantly multiplied from a fraction of the loan amount to the full indebtedness simply because one engaged in any one of various enumerated “bad acts” (such as waste, fraud, misappropriation, bankruptcy, receivership, violation of special purpose entity covenants, or incurrence of subordinate debt without the lender’s consent). Here in Illinois, bad boy Laurance Freed, developer of the long-vacant “Block 37” on North State Street in Chicago, committed such a bad boy act when he had the temerity to contest the bank’s appointment of a receiver and file defenses to the bank’s foreclosure action. Though the ensuing delays were but a mere nuisance for the bank, that didn’t stop the Illinois Appellate Court from affirming that (i) Freed’s nominal challenges to the bank’s actions triggered the full $206 million recourse liability (up from $50 million) and (ii) the increase was not wholly disproportionate to the damages suffered by the bank from having to deal with the nuisance litigation and so was not an unenforceable penalty. In sum, the Court held, if you’re a “bad boy” under your own contractual definition of one, don’t expect a Court to bail you out of your own mess. Bank of America v. Freed, 2012 WL 6725894 (Ill. App. Ct., December 28, 2012) (PDF).

In conclusion, there’s a clear moral to this story:

Except perhaps in sports and art, being a bad boy can be hazardous to life (RIP Mr. Alleman), liberty (Turner / Kurlemann), and the pursuit of happiness (Freed)!

Thanks for reading!

Copyright Steve Jakubowski 2013

Often, the only unencumbered assets left after a company goes bankrupt are potential causes of action against deep-pocketed professionals that witnessed or contributed to the debtor’s demise.  Of course, it’s one thing to allege misconduct; proving it (as noted here) is a horse of a different color.  A trilogy of recent decisions from the 7th Circuit Court of Appeals, however, demonstrates the increasing impatience of courts with plaintiffs who, as the 7th Circuit’s Chief Judge Frank Easterbrook recently put it in one of these cases, sue the debtor’s professionals in an “attempt to find a deep pocket to reimburse investors for the costs of managers’ blunders.”  HA2003 Liquidating Trust v. Credit Suisse Secs. (USA) LLC, 517 F.3d 454 (7th Cir. 2008) (pdf)

The latest failed effort is found in a decision authored by Judge Diane P. Wood, as compassionate and fairand inspirational!–a judge as you’ll find (and possibly the next Supreme Court justice), in Joyce v. Morgan Stanley & Co., Inc., 2008 WL 3844111 (7th Cir. 8/19/08) (pdf).  In this case, Morgan Stanley, once the advisor to RCN, was engaged by 21st Century Telecom Group in late 1999, just before the telecom industry busted, to serve as 21st Century’s financial advisor in an ill-fated stock-for-stock merger with RCN.  As part of its engagement, Morgan Stanley delivered a “fairness opinion” to 21st Century’s board.  Between the 12/12/1999 date of the merger agreement and the 4/28/2000 effective date of the merger, RCN’s stock price plummeted and 21st Century’s stockholders ended up left holding the bag.

Nobody, however, leaves Ed Joyce–a famed Chicago commercial litigator–holding the bag and gets away with it, at least not without a good fight.  The problem for Ed, however, was finding a deep pocket to compensate him and his fellow stockholders for their losses, not an easy task particularly since they first filed suit more than six years after the merger’s effective date.  In their one-count complaint, which alleged “constructive fraud” on the part of Morgan Stanley, Ed and his fellow plaintiffs argued that Morgan Stanley had a duty to advise 21st Century’s shareholders about how to minimize their exposure to a potential drop in RCN’s stock price following execution of the merger agreement.  Morgan Stanley didn’t, they alleged, because that would likely have caused RCN’s stock price to decline.  Further, they alleged, Morgan Stanley didn’t want that to happen because of its conflict-of-interest stemming from the fact that it had served as RCN’s financial advisor before the merger.

Judge Wood, together with Judges William J. Bauer and Terence T. Evans, agreed that Ed and the other shareholders had standing to sue because their claims were direct, not derivative.  That’s all they agreed with, however.   While everyone recognized that in order to tag Morgan Stanley with liability, Morgan Stanley had to owe the 21st Century shareholders a fiduciary duty, here’s where the wheels fell off the bus because the 7th Circuit would not agree that Morgan Stanley owed the 21st Century shareholders a duty of full and fair disclosure.  To the 7th Circuit, the duties of Morgan Stanley were rooted in its engagement agreement, and no extra-contractual fiduciary duty existed to require Morgan Stanley to advise the 21st Century shareholders about hedging strategies that might minimize their exposure to fluctuations in the value of RCN stock.  Judge Wood wrote:

Continue Reading 7th Circuit Nixes Attempts to Hold Investment Bankers Responsible for Matters Beyond Their Engagement Agreements

Thanks to Francis Pileggi, Delaware’s premier blogger, for kindly alerting me to Nelson v. Emerson, 2008 WL 1961150 (Del. Ch., 5/6/08), in which Vice Chancellor Strine issued a well-crafted discourse on the interplay between Delaware’s law governing corporate fiduciaries and federal bankruptcy law governing their conduct.  Francis wrote a long post quoting extensively from Vice Chancellor Strine’s opinion, which I strongly recommend you first read, and will not repeat here.

Briefly, in this case, the company’s former officer, director, and shareholder, wearing his tough guy hat as the company’s major secured creditor, unsuccessfully challenged the company’s bankruptcy filing in Chicago, with Bankruptcy Judge Jack B. Schmetterer issuing a lengthy opinion finding that (i) the former insider’s claims should be only partially recharacterized as equity, but not equitably subordinated, and (ii) most importantly for purposes of this post, the debtor’s chapter 11 filing was not in bad faith because there was a business to reorganize and the filing was a "rational reaction" to the creditor’s threat to foreclose on debtor’s business assetsRepository Technologies, Inc. v. Nelson (In re Repository Technologies, Inc.), 363 B.R 868 (Bankr. N.D. Ill. 2007) (pdf). 

District Court Judge Amy St. Eve, who’s had one of the more interesting years as federal judge while overseeing the Tony Rezko and Lord Conrad Black of Crossharbour trials, heard the appeal in her spare time, and affirmed Judge Schmetterer’s decision in its entirety.  Nelson v. Repository Technologies, Inc., 381 B.R. 852 (N.D. Ill. 2008) (pdf).  This opinion itself is worth reading for its reminder that "[b]ankruptcy is not a ‘free-for-all’ equity balancing act" and that dicta is defined by the Seventh Circuit (see my previous post entitled, Judge Posner’s "Dictum" on "Dicta") as what a court "says" not what it "holds."  Id. at 867, 873.  As regards the latter point, Judge St. Eve concluded, "Nelson’s argument that the Bankruptcy Court’s language is dictum is defeated by his own motion requesting a finding of bad faith in support of dismissing [Repository]’s bankruptcy case."  Id., 381 B.R. at 873

After Judge St. Eve had ruled, Nelson backtracked and recrafted his theory of the case as a breach of fiduciary duty case instead of a bad faith bankruptcy case and filed a complaint in Delaware Chancery Court asserting that management breached its fiduciary duties to the corporation by filing bankruptcy in bad faith.  Adopting the standards for claim preclusion from the 7th Circuit, not Delaware (which were noted to be essentially the same as the 7th Circuit’s), Vice Chancellor Strine held that Nelson was collaterally estopped from asserting a breach of duty claim based on management’s alleged bad faith in filing the bankruptcy petition because, in the first instance, Judge St. Eve had already ruled in the district court case that Judge Schmetterer’s finding on the bad faith issue was not "dicta."  As an aside, one has to wonder whether Nelson miscalculated by first having the District Court, not the Chancery Court, decide whether Judge Schmetterer’s ruling was dicta.  Indeed, Judge St. Eve’s own ruling looks a bit like dicta itself, since that ruling on dicta really wasn’t essential to affirming Judge Schmetterer’s decision.  But once she was asked to decide whether it was in fact dicta, and she did so decide, then Nelson was most definitely bound by that result.

Still, Vice Chancellor Strine covered his bases by not relying exclusively upon Judge St. Eve’s holding that Judge Schmetterer ruling wasn’t dicta, and instead undertook his own independent analysis of Judge Schmetterer’s decision, drawing the following important two conclusions:

Continue Reading Be Careful What You Wish For: Delaware Chancery Court Provides a Cautionary Tale Against Perfunctory Requests “For Other And Further Relief As The Court Deems Just And Equitable”

Davey and Zack are now 6 1/2 months, and finally consistently sleeping through the night!  The temperature in Chicago has also finally hit 60 degrees in Chicago, for only the seventh time this year. Put ’em together, add another great post from my good friend Francis X. Pileggi, the Lou Gehrig of legal blogging, and–without making any vows–it’s time to dust off the blog and awaken from my blogging hibernation.  Thanks to those who’ve reached out to me in the interim with their kind words, comments, suggestions, and encouragement.

Here’s a link to Francis’s recent post on his Delaware Corporate and Commercial Litigation Blog about a decision handed down by one of the country’s preeminent bankruptcy judges, Judge Peter J. Walsh, in Miller v. McDonald (In re World Health Alternatives, Inc.), 2008 WL 1002035 (Bankr. D. Del. 4/9/08) (pdf). In this decision, Judge Walsh refused to dismiss this complaint filed by Francis and his colleagues against Brian Licastro, the former vice-president of operations and in-house general counsel of World Health Alternatives.  The opinion is a must read because–

  • it explicitly extends the so-called Caremark duties to officers of a corporation, and in particular here, to the VP-operations and in-house general counsel, who was alleged "responsible for failing to implement any internal monitoring system and/or failing to utilize such system as is required by Caremark and Araneta"; (Op. at 26.)  
  • it sustains, by a narrow margin, a corporate waste count against the VP/GC, despite his not having personally benefited from the alleged waste, based on the allegation that he was "aware of the alleged corporate waste and took no action, as fiduciaries, to prevent such conduct";  (Op. at 33.)
  • it upholds a negligent misrepresentation count against the VP/GC alleging that "if [he] properly performed his duty as in-house counsel, these misrepresentation[s] [in public filings] would not have been made and the resulting harm [resulting in a $2.7 million payout in a shareholder class action] would have been avoided.  (Op. at 36-37.)

On January 14, 2007, I linked to various 27 bankruptcy-related cases discussed on Francis’s blog.  Time for an update linking to the next 27 bankruptcy-related posts by Francis since then:

Continue Reading Delaware’s Premier Blogger Wins Important Motion Before Delaware’s Judge Walsh Imposing the Caremark Fiduciary Duty on Corporate General Counsel

As every blogger will agree, "thank goodness for guest bloggers!" (especially with my wife now 37 weeks and counting–laboriously so–with twins).

Today’s guest blog is from my colleague at The Coleman Law Firm, Elizabeth E. Richert, who has been at my side–for better or for worse–since her graduation from Duke Law School in 2001.

If you’re wondering how I had the time to blog, it’s in large measure because Elizabeth does a lot of the spade work for me.  If you’re also wondering why I’m not blogging as regularly, well, Elizabeth’s starting to do that for me too.   Unfortunately, I don’t think she does diapers (but see training video here).

So thanks Elizabeth for stepping up to the plate, and congratulations on your first of what I hope will be many more excellent posts!


Continue Reading Judge Peck Rules in Iridium’s Bankruptcy That Stock Market Valuations Are No “Fool’s Game”

Back from a blogging R&R to take time to smell the roses, catch up on the ever-burgeoning e-precedent file, reflect on a year gone by since my mom’s passing, and–most significantly–get the house ready for Malthusian growth with a pair of twins due sometime next month (adding to the two young Jakubowski’s already here)!  So please excuse my patchy blogging as of late, but as Livy first wrote, "better late than never…" (though, for the sake of completeness, I suppose I should add that Livy concluded, "but better never late").

Anyway, back to blogging, and thanks for reading.

As Bob Eisenbach, Francis Pileggi, and Scott Riddle were quick to observe, the Delaware Supreme Court just put the official kibosh on "deepening insolvency" as an independent cause of action.  That is not the end of the story for bankruptcy litigators, however, since Vice-Chancellor Strine’s opinion in Trenwick America Litigation Trust v. Billet, 906 A.2d 168 (Del. Ch. 2006) (pdf), upon which the Delaware Supreme Court relied, doesn’t address whether deepening insolvency remains valid as a theory of damages. 

As to the latter point, as I recapped here and here, last year the Third Circuit in Seitz v. Detweiler, Hershey & Assocs., P.C. (In re CitX, Inc.), 448 F.3d 672 (3d Cir. 2006) (pdf), held that–at least under Pennsylvania law–deepening insolvency "is not an independent form of corporate damage" and that its earlier decision in Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340 (3d Cir. 2001) (pdf), "should not be interpreted to create a novel theory of damages for an independent cause of action like malpractice … [or] for any other cause of action, such as fraud."  In support of this proposition, the Third Circuit pointed to bankruptcy lawyer/novelist Sabin Willett’s oft-cited article, The Shallows of Deepening Insolvency, 60 Bus. Law. 549, 575 (2005), for the proposition that "[w]here an independent cause of action gives a firm a remedy for the increase in its liabilities, the decrease in fair asset value, or its lost profits, then the firm may recover, without reference to the incidental impact upon the solvency calculation."

Two recent opinions authored by the Seventh Circuit’s Judge Posner and the Southern District of New York’s Judge Lewis A. Kaplan, however, don’t adopt this per se rule (or at least, as regards Judge Kaplan, not in its entirety).  In Fehribach v. Ernst & Young LLP, 2007 WL 2033734 (7th Cir. 7/17/07) (pdf), Judge Posner provides the following short discourse on the "controversial theory" of deepening insolvency as a theory of damages (including answering how shareholders might be "ineluctably" harmed by a company’s deepening insolvency):

Continue Reading Damages for Deepening Insolvency: Judges Posner and Kaplan Consider the Elements of Proof

The Truman Show is Jim Carrey’s greatest acting moment and one of Peter Weir’s greatest directorial moments.  In this first reality TV show from which all current variants have been spawned, Jim Carrey plays Truman Burbank, an unwanted baby who’s been adopted by T.V. Corp. to play the lead role in a world that everyone in the world, but him, knows has been staged. 

But what do The Truman Show and Enron have in common?  More than one might think.  Apparently between August 2001 and December 2001, Enron considered engaging Goldman, Sachs & Co. to explore–as Goldman described it in recent Court filings–"options for the company in response to declines in its stock price and perceived takeover vulnerability and to consider the company’s need to prepare for hostile takeovers and sale transactions that might improve its balance sheet."

Goldman’s adversaries in litigation allege in this complaint that Enron’s $1 billion prepayment of short-term commercial paper within 5 weeks of the bankruptcy filing at face value (instead of the junk market price they were really worth) was both a preferential and a fraudulent transfer (Goldman got about $300 million).  They also disputed Goldman’s innocuous description of its discussions with Enron, preferring instead to characterize them as "discussions of a potential engagement under which Goldman would serve as a consultant to advise Enron on ways to stave off the pending financial debacle." 

Curiously, the nickname Goldman pinned on the project was "Project Truman.Deal nicknames often say a lot about the nature of the deal, and given that Enron was by any measure the greatest financial illusion in corporate history, attaching the moniker "Project Truman" on the potential engagement is a telling premonition of trouble afoot.  Still, no one yet has fessed up to who chose that nickname for the project–or why.

Notably, the only reference to "Project Truman" in any actual substantive document produced in the litigation to date is in these "Discussion Materials" that were distributed at a "Project Truman" lunch meeting that Ken Lay and Andrew Fastow had scheduled with Goldman in Woodland, Texas for September 6, 2001, just five days before the tragedy of 9/11 sent the financial markets into a tailspin and effectively dried up whatever liquidity remained at Enron.

On page 6 of the Discussion Materials, the bold-faced-boxed-word "Truman" rests atop a decision tree detailing Enron’s "next steps" after "Truman."  Based on the discussion at page 5 of the materials entitled "What Message Do You Deliver to the Street," the boxed reference to "Truman" sure looks like a convenient tag for the preceding page’s 12-point Truman-esque bubble-bursting "message to the street."  The Goldman decision tree under the bold boxed word "Truman" suggests that once "Truman" confronts reality, one should first measure the effect of that reality check on "credit stability."  If the effect is positive (or "yes"), then continue to the next level down and determine whether "establishing counterparty confidence" can be achieved.  Conversely, if the effect on credit stability is negative (or "no"), then say sayonara to Enron in a "quick sale."  For his part, Fastow had this to say about the Project Truman meeting with Goldman, which was quite a different spin on the meeting than Lay recounted at trial.

Back now to the avoidance litigation over the pre-bankruptcy payoff of the junk commercial paper.  In February of this year, a few of the defendants in this protracted litigation (docket here) requested from Goldman all documents relating to Project Truman.  Goldman respectfully declined, arguing that it was irrelevant.  The defendants moved to compel production (joined by the Enron litigation trust).  Goldman objected and the movants replied (as did Enron).

Judge Arthur Gonzalez (a former 13 year veteran schoolteacher in New York’s public schools who won the equivalent of the "Bankruptcy Judge Lottery" by having been randomly selected to be the presiding judge — at the same time — over the two largest bankruptcies of all time: Enron and Worldcom), took little time to decide this discovery dispute.  Just nine days after about 800 pages in briefs and exhibit attachments had been finally submitted, he issued this ruling granting the motion to compel production, concluding:

light of (1) the discovery posture of this case following a denial of a motion to dismiss and motion to stay discovery; (2) the broad definition of relevance articulated in Fed. R. Civ. P. 26, (3) the overall relevance of the Project Truman materials to the issues of Goldman’s agency and good faith, and (4) the acknowledged lack of burden on Goldman to produce such material, this Court finds that the motion to compel is warranted.

Judge Gonzalez also rejected Goldman’s suggestion for an in camera review of the materials, stating:

Such review is more appropriate in circumstances involving privileged or confidential information. The Court agrees with the Movants that a court’s in camera inspection “is no substitute to full disclosure to, and review of the disputed materials, by a litigant’s counsel, who is best positioned to know the party’s strategy and assess the relevance vel non of the information contained within the disputed materials.

Of course, my theory on why Truman was selected as the nickname for the deal is complete speculation.  But considering that the movie had been released three years earlier, and only two years earlier on video, perhaps the movie was still fresh in the mind of a Goldman deal kingpin looking for a creative–and apt–nickname for the bursting of the greatest financial illusion in corporate history.  Time will tell.

© Steve Jakubowski 2007

Bankruptcy and restructuring attracts one who yearns to be a "Renaissance Man" because business failure is everywhere and does not discriminate among industries…including, for example, the rap industry.  Indeed, only bankruptcy can prompt one to ask:  "Why were the prices for rap/hip-hop slashed [in Tower Records’ bankruptcy sale] vastly more than those of every other genre of music?"

Rap stars, of course, are no strangers to bankruptcy, though generally you won’t find their case without knowing "what their mommas named them."  Perhaps the most famous rapper to have gone bankrupt is MC Hammer (a/k/a Stan Burrell), who filed for bankruptcy in 1996 with debts of $14 million, and whose song copyrights were recently sold for $2.7 million.  [Hammer is now a blogger, minister, and proud father!]

Not surprisingly, rappers’ bankruptcies are highly contentious, as demonstrated by the long rap sheets (i.e., bankruptcy dockets) in Hammer’s never-ending case, and–more recently–in the bankruptcy cases of the legendary Death Row Records and its founder Marion "Suge" Knight, Jr.

But, "what goes around, comes around," as the not-so-old saying goes, even (or especially) in the rap business.  In 1998, Death Row filed a complaint for nondischargeability against Hammer, and obtained a $1.7 million nondischargeabilty judgment against him.  Now, Nathaniel Hale (not the famous spy, but Snoop Dogg’s less-but-still famous cousin Nate Dogg), just filed his own multimillion nondischargeability complaint against Death Row’s founder, who has clearly seen better days.

This long-winded introduction, however, is just by way of background to the real point of this blog post, which is to recap the 11th circuit’s decision this week in Thompkins v. Lil’ Joe Records, Inc., 2007 WL 316302 (11th Cir. 2/5/07) (pdf), which can be boiled down to simply this:

A once successful rap recording company (2 Live Crew Luther Campbell’s acclaimed Luke Records) enters into a contract with a future rap star (Jeff Thompkins, a/k/a JT Money of Poison Clan) in which JT unconditionally transfers all right, title, and interest in his sound recording copyrights to Luke Records in exchange for a "guaranteed" royalty stream.  Six years later, in 1995, Luke Records is tied up in chapter 11, where it eventually rejects JT’s contract and transfers the copyrighted sound recordings to Lil’ Joe Records in a "free and clear" bankruptcy sale.

JT subsequently sues Lil’ Joe Records for copyright infringement, claiming that rejection of his executory agreement also rescinded Luke Records’ ownership of the copyrights.  The 11th Circuit, however, disagreed and held that ownership rights in the copyrighted song recordings did not revert back to JT upon rejection of the executory portions of the transfer agreement.  The 11th Circuit wrote:

[T]he bankruptcy court’s Confirmation Order did not effectively rescind the 1989 Agreement and reverse the executed transfer of the Poison Clan Song copyrights to Luke Records.  The rejection had no effect on Luke Records’ ownership of the copyrights, and they passed from the estate to Lil’ Joe under the terms of the Joint Plan and Confirmation Order….  Accordingly, [JT] cannot support a claim of copyright infringement against Lil’ Joe as to the Poison Clan Songs, and we affirm the grant of summary judgment on that claim in favor of Lil’ Joe.

In other words, to quote the rap group Souls of Mischief, "You got f**ked in the industry!"

2/8/07 UpdateBe sure to check out Bob Eisenbach’s follow up to this post where he analyzes how novice IP holders can avoid getting f**ked in the industry as poor JT Money just did.

2/22/07 UpdateFor those more interested in IP issues in bankruptcy, here are two presentations I’m delivering at this scheduled event of the Licensing Executive Society Winter 2007 Meeting in San Francisco:

  • IP Licensing & BankruptcyAn Issue Spotting Checklist for Analyzing Questions Regarding Assumption, Rejection, and/or Assignment of IP Licenses in Bankruptcy

                –   and  –

© Steve Jakubowski 2007

Back from my blogging vacation, during which I instead devoted significant chunks of spare time to bringing current a project I started in 2004 — that of electronically sorting cases, articles, and news stories from the past 3-5 years (now numbering about 10,000) into various topical e-folders in MS-Outlook, thus putting my entire precedent file literally at my fingertips.  The quantum leaps in productivity from technology never cease to amaze me!  What in the early 90’s absorbed the full-time efforts of two paralegals to assemble and maintain and entire banks of cabinets on high-rent office floors to store, today can be compiled, archived, and retrieved by me alone from the comfort of wherever I’m sitting in 1/50th the time it once took.  Remember the sea-change effected not that long ago by the fax, prompting many a young lawyer to ask "what did people ever do without a fax?"  How incredibly fast the world has changed!  Hopefully, however, Stephen Hawking and his scientist friends are wrong and all this rapid change doesn’t spell our swift destruction!

Anyway, being nearly done with that project — for now — it’s back to blogging.  Lots of interesting case developments have passed through my porous sieve, but it’s hard to pass up commenting on today’s salacious front page story in the Wall Street Journal (referenced here) about the collapse of Student Finance Corp. (SFC) and the actions of its counsel, Pepper Hamilton (and partner W. Roderick Gagne in particular).

Most of the article’s central allegations regarding Pepper Hamilton’s culpability rest upon the allegations made in the trustee’s 67 page, first amended complaint.  In its 12/22/05 ruling on Pepper Hamilton’s motion to dismiss, however, the Court tossed most of the trustee’s more attenuated claims against Pepper Hamilton (such as deepening insolvency, negligent misrepresentation, and aiding and abetting breach of fiduciary duty), while leaving intact the trustee’s primary causes of action for breach of fiduciary duty and professional malpractice.  Stanziale v. Pepper Hamilton, et. al. (In re Student Finance Corp.), 335 B.R. 539 (D. Del. 2005) (pdf).

The WSJ article concludes that "Pepper Hamilton’s own day in court against the bankruptcy [trustee] … is scheduled for October."  In fact, however, if Pepper Hamilton’s latest arguments to the Court succeed, there will be no day in Court for Pepper Hamilton (or if there is, it’ll be a short day), since the guts of the trustee’s complaint will have been eviscerated and there will be little of real substance left to litigate!

What is it that led to Pepper Hamilton’s surge of optimism?  None other than the Third Circuit’s recent decision (reviewed at length here) in Seitz v. Detweiler, Hershey & Assocs., P.C. (In re CitX Corp.), 448 F.3d 672 (3d Cir. 5/26/06) (pdf), which (as noted here) arguably went farther than it needed to by "hold[ing], unnecessarily, that deepening insolvency is not a valid theory of damages for other independent torts." 

Pepper Hamilton picked up on this theme that CitX (or Seitz) should be broadly construed to apply to other independent torts and within weeks of the decision filed this "omnibus brief" in support of its motion for judgment on the pleadings.  In it, Pepper Hamilton advanced the following argument:

Continue Reading The Student Finance Corp. Debacle: Pepper Hamilton’s Court Retort