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

 

A 7th Circuit opinion authored by Chief Judge Easterbrook last week had me again looking across the street at 203 North LaSalle and wondering whether the US Supreme Court will ever finally decide whether there is a “new value” exception to the absolute priority rule (which requires that when an unsecured creditor class objects to a plan of reorganization, it must be paid in full before junior claims or interests get anything).

The question of whether there’s a “new value” exception to the absolute priority rule (i.e., whether old equity can contribute new capital and receive new equity interests in the reorganized entity) was expressly left open by the US Supreme Court in Bank of America National Trust & Savings Ass’n v. 203 North LaSalle Street Partnership526 U.S. 434 (1999).  Before the case went to the Supreme Court, the 7th Circuit ruled in 203 N. LaSalle  that the oft-ignored decision in Case v. Los Angeles Lumber Products Co.308 U.S. 106 (1938), provided the basis for the new value exception in cases where the equity interest holder contributes new value that is both reasonably equivalent to the value of the equity interest and necessary for the debtor’s successful reorganization.  In re 203 N. LaSalle St. P’ship, 126 F.3d 955 (7th Cir. 1997).  While refusing to specifically endorse a new value exception or “corollary” to the absolute priority rule, the Supreme Court in 203 N. LaSalle held: “[A]ssuming a new value corollary [exists], [then] plans providing junior interest holders with exclusive opportunities free from competition and without benefit of market valuation” violate the absolute priority rule.”  203 N. LaSalle, 526 U.S. at 458.

In In re Castleton PlazaNo. 12–26392013 WL 537269 (7th Cir. Feb. 14, 2013), the 7th Circuit Court of Appeals faced an issue never before addressed by a Court of Appeals, that being whether “an equity investor can evade the competitive process by arranging for the new value to be contributed by (and the new equity to go to) an ‘insider’ [as defined in the Bankruptcy Code]”?  The 7th Circuit found no difficulty in answering this question with a resounding “NO”!  Notably, instead of chopping through the bramble bush of nuanced statutory interpretation, the Court’s opinion relied principally on broad bankruptcy policy objectives.  The Court stated:

In 203 North LaSalle the Court remarked on the danger that diverting assets to insiders can pose to the absolute-priority rule.  526 U.S. at 444.   It follows that plans giving insiders preferential access to investment opportunities in the reorganized debtor should be subject to the same opportunity for competition as plans in which existing claim-holders put up the new money….

Nor does the rationale of 203 North LaSalle depend on who proposes the plan. Competition helps prevent the funneling of value from lenders to insiders, no matter who proposes the plan or when.  An impaired lender who objects to any plan that leaves insiders holding equity is entitled to the benefit of competition.  If, as [the debtor and insiders] insist, their plan offers creditors the best deal, then they will prevail in the auction.  But if, as [the objecting secured lender] believes, the bankruptcy judge has underestimated the value of [the debtor’s] real estate, wiped out too much of the secured claim, and set the remaining loan’s terms at below-market rates [via cramdown], then someone will pay more than $375,000 (perhaps a lot more) for the equity in the reorganized firm.

The judgment of the bankruptcy court is reversed and the case is remanded with directions to open the proposed plan of reorganization to competitive bidding.

But if the plan was confirmed, how is it that the direct appeal of the plan confirmation order to the 7th Circuit did not get mooted out through substantial consummation of the plan?  Simple.  The parties in this motion stipulated to entry of this order by the Bankruptcy Court, thereby staying the effectiveness of the confirmation order pending resolution of the issue on appeal.  Of course, since the only major creditor in the case was the senior secured lender (with a large unsecured deficiency claim) who was objecting to the plan, it had a lot more flexibility in respect of the bonding requirement necessary to stay the effectiveness of the confirmation order pending appeal.  Indeed, as the Court-approved disclosure statement demonstrates, the secured lender appealing the decision was virtually the only creditor of significance in this single asset real estate case.  As such the lender here really didn’t have much to lose by appealing the order since obtaining a stay of the confirmation order pending appeal likely would not have required it to dig very deep to come up with the funds necessary to post a bond and obtain a stay pending appeal.

Is this decision significant?  You bet, and I expect it to reverberate loudly as time progresses.  Before this decision, creative lawyers could reach into their trick bag and try to evade 203 N. LaSalle’s competitive bidding requirements by arguing that the statute doesn’t apply to “new value” contributors who held no equity interests prepetition.  They then could solicit the support of senior secured creditors and propose a “new value” plan acceptable to the secured lender that would call for “new value” contributions from friendly sources and thereby squeeze value to which the intervening unsecured class would be entitled under the absolute priority rule.  And since unsecured creditors in more complex business reorganizations—unlike secured lenders in single asset real estate cases—generally lack the financial incentive or wherewithal to obtain a stay of a plan confirmation order pending appeal, they are swiftly mooted out in the process, leaving equity to walk away with the value while unsecureds are left “holding the bag” (as our founding fathers were wont to say).

Now, however, with the 7th Circuit’s decision in the books, there’s no authority for filing such plans in the first place (at least in the 7th Circuit, though I expect other Courts and Circuits will follow its lead).  Of course, there’s always the hope that the Supreme Court will take this case up on appeal given how rarely such issues wind their way through the appeals process without getting mooted out along the way.  That was a good reason for the Court to take upRadLAX and is an equally good reason to take up this decision too (particularly since, as the 7th Circuit noted, “[b]ankruptcy judges have disagreed on the answer” to the question posed by the case).

Finally, it’s worth noting how a rather simple and seemingly straightforward Supreme Court decision like the one inRadLAX can never be underestimated.  To the 7th Circuit, RadLAX established a policy directive of “protect[ing] creditors against plans that would give competing claimants too much for their new investments and thus dilute the creditors’ interests.”  That’s the first time I’ve seen RadLAX being cited for such a broad policy objective.  It is a principle worth remembering, however, especially when responding to legal gimmickry that attempts to grind Bankruptcy Code provisions like trees in a wood chipper.  Such gimmicks simply won’t carry the day, regardless of their artfulness and basis in principles of statutory construction, where they undermine important policy objectives established in Supreme Court precedent.

Thanks for reading!

©  Steve Jakubowski  2013

Here’s more in the continuing "Year in Review" series.  The inset photo is of the Senator Thad Cochran United States Bankruptcy Court in Aberdeen, Mississippi (pictures and story here), a 47,000 square foot complex that is home to the Bankruptcy Court for the Northern District of Mississippi, where Bankruptcy Judges Houston and Olack sit.  Last year there were 6,101 total bankruptcy filings in the Northern District of Mississippi.  By way of comparison, the Bankruptcy Court for the Northern District of Illinois–which could probably fit in the lobby of this mammoth structure–had the most filings at 59,093.  Talk about influence! 

Continue Reading Bankruptcy Tweets of 2011-2012 Cases – A Year in Review – V.9

Here’s more in the continuing "Year in Review" series.  Catching up after the long Jewish holiday season.  The inset photo is of the Garmatz Federal Courthouse (story here), home to the Bankruptcy Court for the District of Maryland in Baltimore, where Bankruptcy Judges Alquist, Derby, Gordon, Rice, and Schneider sit.

Continue Reading Bankruptcy Tweets of 2011-2012 Cases – A Year in Review – V.8

 

Here’s more in the continuing “Year in Review” series.  The inset photo is of the Jacob Weinberger US Courthouse (story here), home to the Bankruptcy Court for the Southern District of California in San Diego, where Bankruptcy Judges Adler, Bowie, Mann, Meyers, and Taylor sit.

Continue Reading Bankruptcy Tweets of 2011-2012 Cases – A Year in Review – V.7

Here’s more in the continuing "Year in Review" series, catching up on more of my backlog of twitter posts of case developments in the past 12 months.

Each post in this Year in Review series features a different federal courthouse in each state of the Union. The inset photo is of the US Courthouse for the Bankruptcy Court for the Northern District of California in Oakland, California, which is home to Bankruptcy JudgesEfremskyHammond, and Lafferty.

 

Continue Reading Bankruptcy Tweets of 2011-2012 Cases – A Year in Review – V.6

 

Here’s more in the continuing “Year in Review” series, catching up on more of my backlog of twitter posts of case developments in the past 12 months.

Each post in this Year in Review series features a different federal courthouse in each state of the Union. The inset photo is of the US Courthouse for the Bankruptcy Court for the Eastern District of California in Fresno, California, where 28 dairies have filed chapter 11 in 2012, and which is home to Bankruptcy Judges Clement, Ford, Lee, and Rimel.

Continue Reading Bankruptcy Tweets of 2011-2012 Cases – A Year in Review – V.5

 

Here’s more in the continuing “Year in Review” series, catching up on more of my backlog of twitter posts of case developments in the past 12 months.

Each post in this Year in Review series will feature a different federal courthouse in each state of the Union. The inset photo is of the US Courthouse for the Bankruptcy Court for the Eastern District of Arkansas in Little Rock, home to Bankruptcy Judges Evans, Mixon and Taylor.

Continue Reading Bankruptcy Tweets of 2011-2012 Cases – A Year in Review – V.4

Continue Reading Bankruptcy Tweets of 2011-2012 Cases – A Year in Review – V.3

Here’s more in the continuing "Year in Review" series, delivering more of my backlog of twitter posts of case developments in the past 12 months.  RSS Feeds are also available of my Twitter post, which later are collected here.  My 1,500 previous twitter posts of case developments are here.

The inset photo is of the Federal Courthouse for the Bankruptcy Court for the Northern District of Alabama, Eastern Division, in Anniston, Alabama, where Judge James E. Robinson presides.

Continue Reading Bankruptcy Tweets of 2011-2012 Cases – A Year in Review – V.2