There’s plenty of yarns spun in bankruptcy litigation, but rarely do you see one involving a bankrupt yarn spinner. The case of Active Wear, Inc. v. Parkdale Mills, Inc., (2005 WL 2453102) (W.D.Va., 10/4/2005) provides such a tale.
In this case, the defendant provided the debtor with much yarn to be spun into whole cloth. When the debtor could spin no more, and ceased operations, it still had significant quantities of the defendant’s unspun yarn in inventory. It also owed the defendant $2 million in unpaid bills. The defendant promptly made a reclamation claim for return of certain unused yarn, the value of which was determined to be $11,428.88. The defendant subsequently picked up all the unused yarn held by the debtor, who reduced the outstanding debt owed to the defendant by $134,849.50.
Within 90 days of the yarn’s being reclaimed by the defendant, an involuntary Chapter 7 bankruptcy was filed against the debtor, which was not contested. The debtor subsequently brought a preference action against the defendant seeking to recover as preferential the value of the property transferred within 90 days of the petition date.
The Bankruptcy Court held that the debtor could recover, as a preferential transfer, the liquidation value of certain yarn returned, valued at $27,459.00. On appeal, the debtor argued that the yarn should have been valued at fair market value (or the “price which Parkdale could realize from re-selling the yarn”). The Court held:

Active Wear [the debtor] may be correct that the term “value,” in 11 U.S.C. § 550 refers to “fair market value;” however, the appellant’s assertion that “fair market value” is determined by the value of the property to the creditor is misplaced. Instead, “fair market value” refers to the value that the debtor/bankrupt could receive for the property in a liquidation sale….
Case law and statutory law demand that the value which must be assigned to the yarn in this case is the fair market value that could be obtained for the yarn in a liquidation sale held by Active Wear. Furthermore, to give Active Wear credit for the fair market value that could be realized by Parkdale after the return of the yarn, would require giving Active Wear the benefit of Parkdale’s expense in employing its expertise, time, good will, and advertising to re-sell the yarn to another of its customers. Such a result is not supported by case law, statutory law, or common sense.

It’s not clear what would have happened in this case had Active Wear not ceased operations but had remained an operating entity, and whether in such instance the court would have allowed for a “going concern” type valuation of the returned inventory. The stark language of this case, however, doesn’t seem to support such a spin.
© Steve Jakubowski 2005

A recent case from Chicago’s bankruptcy court in the Florsheim Group bankruptcy, (2005 WL 2461145) (Bankr. N.D. Ill., 9/30/05), examines the extraterritorial reach of preference actions, in this case against a Taiwanese company that voluntarily contracted with the debtor to deliver goods in the United States, but otherwise had no connection with the US. With the parties wisely stipulating to the relevant facts, resolving certain defenses, and agreeing to the amount of judgment if the debtor should prevail, three related issues remained for resolution by the Court:
© Steve Jakubowski 2005

1) whether the preferential transfers occurred in the United States or abroad;
2) if the transfers occurred abroad, whether Congress intended §§ 547 and 550 of the Bankruptcy Code to apply extraterritorially; and
3) in any event, whether principles of international comity weigh against applying § 547 to the transfers.

After careful review, the court concluded that the preferential transfers occurred primarily in the United States, and that it therefore didn’t have to consider the most interesting question–that is, whether Congress intended to apply § 547 extraterritorially. The court concluded that principles of international comity don’t apply either since there was no parallel proceeding in any other country that competed with the bankruptcy case, and entered judgment in favor of the debtor in the amount agreed between the parties.
This case is a quick and worthwhile read for those of you involved in preference litigation that raises extraterritoriality concerns.
Steven Jakubowski

The bankruptcy court overseeing Conseco’s massive bankruptcy case has issued a second opinion addressing the scope of a bankruptcy court’s post-confirmation jurisdiction in litigation involving the reorganized – or “New” – Conseco. In its earlier ruling (318 B.R. 425), the court concluded that it did not have jurisdiction over the reorganized debtor’s adversary proceeding against the debtor’s former officers and directors who had defaulted under Conseco’s prepetition loan programs. The court reasoned that bankruptcy’s broad “related to” jurisdiction is far more limited following plan confirmation than it is pre-confirmation, and that it “exists primarily to ensure that the plan is implemented and to protect estate assets devoted to implement the confirmed plan.”
More recently, the Conseco court held that, despite the fact that “the Seventh Circuit takes the most restrictive view of bankruptcy jurisdiction of any circuit,” “related to” jurisdiction existed over an adversary proceeding in which New Conseco sought to enjoin a class action filed in Pennsylvania state court against the reorganized debtor based primarily on contracts that took effect post-confirmation. (2005 WL 2292706). This is because, the court explained, the question of whether the class action violates a discharge injunction is within the “core” jurisdiction of the court.
The existence of post-confirmation jurisdiction in a bankruptcy court is a fact intensive matter that requires careful consideration and planning before the plan is confirmed, not afterwards. And as these cases illustrate, resolution of the question can yield surprising and disappointing results for the losing litigant. Surely New Conseco didn’t expect to be precluded from suing its officers and directors for prepetition loan defaults. Nor is it likely that the class action plaintiffs expected to have to defend themselves in the bankruptcy court for asserting claims that arose post-confirmation. Such are the traps that await experienced and unexperienced bankruptcy litigators alike. Caveat Litigator!
© Steve Jakubowski 2005

Generally, a creditors’ committee or individual creditors seek derivative standing to sue when the debtor-in-possession (DIP) refuses to bring suit. Recently, the Second Circuit addressed a “converse situation” of first impression in In re Smart World Technologies, LLC: that is, whether derivative standing is approriate in the Rule 9019 settlement context when the debtor is alleged to be unjustifiably pursuing a claim and/or refusing to settle.
The Second Circuit’s opinion provides many important lessons to bankruptcy litigators. One is that the buck apparently stops with the debtor-in-possession when it comes to pursuing and/or settling litigation claims. Another is that zealous advocacy of your client’s interests, even when everyone–including the judge–thinks you’re a moron, sometimes pays off.
In overturning the decision of the bankruptcy court, the Second Circuit stated:

We conclude that while authority to pursue a Rule 9019 motion may, in certain limited circumstances, be vested in parties to the bankruptcy proceeding other than the debtor-in-possession, those circumstances are not present here…. We do not rule out that in certain, rare cases, unjustifiable behavior by the debtor-in-possession may warrant a settlement over the debtor’s objection, but this is not such a case.

In passing, the Second Circuit did not hide it’s displeasure at the bankruptcy court’s having apparently ruled more on emotion, than on a developed record:

[H]aving searched the record in vain for anything more than a conclusory statement from the bankruptcy court as to the merits of Smart World’s claims against Juno, we find it difficult to understand how the lower courts could have formed such a firm opinion that Smart World’s claims lacked viability.

At the Rule 9019 hearing, for instance, Smart World’s counsel stated “[w]e think Your Honor needs to make a record here, and make findings as to the range of reasonableness as to the settlement.” Counsel further offered to provide testimony as to “the factual circumstances underlying the various claims” and a “calculation based on [the witness’s] knowledge of the potential value of the claims.” The bankruptcy court brushed the offer aside, stating “[t]here’s no need for him to do that.” Even WorldCom’s counsel pointed out to the bankruptcy court that it had not heard Smart World’s explanation of its “theory of recoveries, claims and damages,” a fact that the court found untroubling….

Continue Reading When It Comes to Settlements, the Debtor in Possession Makes the Call