December 2012 marked the fifth anniversary of the beginning of
the Great Recession, which officially began in December 2007 and
ended in June 2009 (at least in the U.S.). Five years down the
road, the U.S. economy is undeniably on the road to recovery, with
unemployment down to 7.8 percent from a high of 10.2 percent in
October 2009, a significant drop in mortgage-foreclosure rates, and
a housing market strengthened by the lowest mortgage rates in
history. Even so, the recovery is shaky. Much remains to be done to
restore the world's largest economy to sustainable growth and a
positive outlook.
Characteristically divisive U.S. lawmakers in the dysfunctional
112th Congress actually failed to reach a deal in 2012 to avoid
hurling the nation over the "fiscal cliff." However, in a
(post)-last-minute ploy to prevent automatic spending cuts, the
largest tax increase in U.S. history, and a relapse into recession,
Congress worked out a compromise on January 1, 2013, that, among
other things, repeals most of the Bush-era tax cuts for wealthy
Americans, avoids tax increases on middle-class families,
temporarily defers deep military and other government spending
cuts, restores financial aid to farmers, and extends unemployment
benefits.
Among the most memorable business, economic, and financial sound bites of 2012 were "LIBOR scandal," "Taxmaggedon," "QE3," "fiscal cliff," "sequestration," "Flash Crash II," and "the London Whale."
Now for the bad news. For the fourth year running, the U.S. ran
a deficit in excess of $1 trillion for the fiscal year
("FY") ending September 30. Also, in a reprise of 2011,
the U.S. reached its legal borrowing limit on December 31, giving
Congress just four months (as extended pursuant to a deal reached
in late January) before it must raise the debt ceiling (again), or
(again) risk causing the government to default on its bills and
financial obligations. In addition, the "sequestration"
automatic spending cuts avoided on January 1 were only temporarily
deferred. Stay tuned for Fiscal Cliff II.
U.S. unemployment remains stubbornly high, compared to the 4.9
percent unemployment rate in December 2007. At the end of 2012,
12.2 million Americans were unemployed (not counting the
underemployed and those who have dropped out of the workforce). The
U.S. Labor Department reported on January 4, 2013, that American
employers added 155,000 jobs in December, leaving the unemployment
rate unchanged at 7.8 percent, the level at which it has more or
less remained since September. Overall, the country added 1.8
million jobs during 2012.
Food prices in the U.S. spiked at the end of 2012 and will continue
to be higher in 2013, after the nation's worst drought in 50
years—2012 was the hottest year ever recorded in the
contiguous United States—sent prices for corn, soybeans,
feed, and related products (e.g., ethanol and meat) soaring.
A report released by the U.S. Education Department and the Consumer
Financial Protection Bureau in July 2012 estimated that total
outstanding student-loan debt in the U.S. for the first time
exceeded $1 trillion (with an average loan balance of more than
$23,000), surpassing the total U.S. credit-card balance ($693
billion) and the total U.S. auto-loan balance ($730 billion).
Moreover, as the number of people taking out U.S. government-backed
student loans has exploded, so has the number of those who have
fallen at least 12 months behind in making payments—about 5.9
million people nationwide, up about a third in the last five years.
In all, nearly one in every six borrowers with a student-loan
balance is in default. Student-loan debt collection is a booming
business. In FY 2011, the U.S. Department of Education alone paid
more than $1.4 billion to collection agencies and other groups to
hunt down defaulters. On July 6, 2012, President Obama signed
legislation freezing federally subsidized student-loan rates for a
year, averting a doubling of interest rates. The change helped more
than 7 million students.
The latest U.S. Census Bureau data shows that the number of
impoverished Americans increased from 49 million in 2010 to 49.7
million in 2011. The report also states that nearly 20 percent of
American children continue to live in poverty. In September 2012,
the Bureau reported that the income gap between the wealthiest 20
percent of American households and the rest of the country grew
sharply, as an overwhelming majority of Americans saw no gains from
a weak economic recovery. Median household income after inflation
fell to $50,054, a level that was 8 percent lower than in 2007, the
year before the recession took hold.
Fewer Americans filed for personal bankruptcy in 2012: 1.13 million
individuals filed for bankruptcy last year, 14 percent fewer than
in 2011, and the fewest since 2008, according to Epiq Systems,
Inc.
Only 51 U.S. banks failed in 2012, compared to 92 in 2011, 157 in
2010 (more than in any year since the savings and loan crisis of
the early 1990s), and 140 in 2009. The number of bank failures was
the lowest since 2008, when 25 banks failed. Since 2008, a total of
465 banks with assets aggregating more than $680 billion have been
closed by regulators. On the basis of recent trends, however, it
appears that the U.S. banking system is slowly stabilizing as banks
complete divestitures of toxic mortgage assets. At the close of FY
2012, the number of banks on the Federal Deposit Insurance
Corporation's confidential "problem list" fell to
694—about 9.6 percent of all federally insured banks. At its
peak in the first quarter of 2011, the number of troubled banks was
888, or 11.7 percent of all federally insured institutions.
Headlines in 2012 continued to herald the dire financial straits of
U.S. states and municipalities. A variety of factors have combined
to create a virtual maelstrom of woes for U.S.
municipalities—a reduction in the tax base caused by
increased unemployment; plummeting real estate values and a high
rate of mortgage foreclosures; questionable investments;
underfunded pension plans and retiree benefits; decreased federal
aid; and escalating costs (including the higher cost of borrowing
due to the meltdown of the bond-mortgage industry and the demise of
the market for auction-rate securities). The burden has been too
great for some municipalities to bear. Some have turned to chapter
9 bankruptcy protection for relief.
California led the charge in 2012, with three of its municipalities
filing for bankruptcy, including the largest U.S. city to file for
chapter 9 protection (the City of Stockton). In all, 15
municipalities (most of which were water and sanitary districts,
hospital authorities, or state-run off-track betting enterprises)
filed for bankruptcy protection in 2012, compared to 13 in 2011 and
7 in 2010.
Business Bankruptcy Filings
Business bankruptcy filings dropped off in both FY and calendar
year 2012. However, public-company bankruptcy filings remained the
same. According to data released by the Administrative Office of
the U.S. Courts, business bankruptcy filings in FY 2012 totaled
42,008, down 16 percent from the 49,895 business filings reported
in FY 2011. Chapter 11 filings fell to 10,597, down 12 percent from
the 11,979 chapter 11 filings reported in FY 2011.
According to court data compiled by Epiq Systems, there were 7,760
business chapter 11 filings in calendar year 2012, compared to
8,658 filings in 2011, a decline of approximately 10 percent. All
told, commercial bankruptcy filings fell 22 percent in 2012 to
57,788. The drop-off can be attributed to a number of factors,
including the continuation of an "amend and extend" (or
"extend and pretend") mentality by many lenders loath to
redeploy capital in a market with historically low interest
rates.
The number of bankruptcy filings by "public companies"
(defined as companies with publicly traded stock or debt) in 2012
was 86, according to data provided by New Generation Research,
Inc., tied for the fewest since 2007. There were also 86
public-company filings in 2011, whereas 106 public companies filed
for bankruptcy in 2010, and 211 did so in 2009.
The year 2012 added 14 names to the billion-dollar public-company
bankruptcy club, compared to 12 in 2011, 19 in 2010, and 52 in
2009. Counting private-company and municipal filings, the
billion-dollar club gained 22 members in 2012.
The largest bankruptcy filing of 2012—Residential Capital,
LLC, with $15.7 billion in assets—was the 35th-largest filing
of all time, based upon asset value. Nineteen public and private
companies with assets greater than $1 billion exited from
bankruptcy in 2012. In a change from recent years, more of these
companies reorganized than were liquidated or sold. Two of the most
prominent names on the list were Lehman Brothers Holdings Inc., the
largest bankruptcy filing ever (which returned a 100 percent
recovery to brokerage customers), and Washington Mutual Inc., the
second-largest bankruptcy of all time.
According to Standard & Poor's ("S&P"), the
global number of corporate defaults in 2012 exceeded the number of
defaults in 2010 and 2011. A total of 82 issuers defaulted in 2012,
surpassing the 53 defaults in 2011 and the 81 defaults in 2010.
However, the number of defaults in 2012 was significantly lower
than the 264 defaults recorded in 2009. Forty-seven of 2012's
defaults were based in the U.S., followed by 22 in emerging
markets. Nine were based in Europe, while four were based in other
developed regions. Missed interest or principal payments and
bankruptcy filings were the top reasons for defaults in 2012,
followed by distressed exchanges.
Completed distressed-debt and bankruptcy restructuring activity
totaled $422.6 billion over the course of 2012, according to
Thomson Reuters, a 102.6 percent increase compared to the $208.6
billion accrued during 2011. In total, 430 deals totaling $470.8
billion were announced in 2012—344 fewer deals compared to
the same period in 2011. Activity was led by Greece's $263.1
billion debt-exchange transaction, the largest restructuring deal
on record. U.S. deal activity totaled $61.6 billion in 2012, a 19.2
percent decrease from 2011. There were 129 announced U.S.
restructuring transactions during 2012, 107 fewer than in the
previous year.
Where Do We Go From Here?
The outlook for 2013 in the U.S. business bankruptcy world looks
much as it did in each of the past two years. Low interest rates
and freer credit markets mean that troubled companies (as well as
their lenders) are less likely to opt for a reorganization strategy
that incorporates a garden-variety bankruptcy filing. As in years
past, prepackaged or prenegotiated chapter 11 cases and quick-fix
section 363(b) sales are likely to be the norm. Bankruptcy
prognosticators have highlighted the health-care, real estate,
retail, shipping, energy, and professional sports sectors as having
companies deemed "most likely to fail."
The transformation of chapter 11 bankruptcies during the 35 years
since the Bankruptcy Code was enacted in 1978 has prompted calls
for a hard look at reform. A variety of factors are driving the
need for changes. These include: (i) increased use of secured
credit throughout capital structures; (ii) an explosion in the
growth of distressed-debt markets and claims trading that has made
chapter 11 a takeover strategy; (iii) owner and creditor agendas
that go beyond traditional restructuring; (iv) a change from
debtors engaged principally in manufacturing to service companies,
such as retailers and technology-driven enterprises relying less on
hard assets and more on financial contracts; and (v) the increasing
prominence of cross-border bankruptcy cases with international-law
implications. A commission established by the American Bankruptcy
Institute to study chapter 11 reform held five meetings in 2012 and
expects to issue a report of its recommendations in April
2014.
Europe
The eye of the global financial storm stalled over Europe in
2012, where the tempest continues to threaten the 27-nation
European Union, or at least the 17-member eurozone. Austerity
measures implemented by Greece, Spain, Italy, Britain, and
Portugal, among others, have proved to be both unpopular and
unsuccessful. S&P downgraded the credit ratings of France,
Italy, Spain, and six other European countries in 2012—a
reminder that Europe's economic woes are far from over. The
only eurozone nations retaining their top AAA ratings are Germany,
the Netherlands, Finland, and Luxembourg.
According to Eurostat, the EU's statistics office, the 17
countries that use the euro ended 2012 at a record high
unemployment rate of 11.8 percent (more than 26 million), the
highest level since the euro was launched in 1999.
Greece reached an agreement with its private creditors in 2012 to
secure the biggest sovereign restructuring in history, paving the
way for a second bailout of the debt-ridden nation and averting an
economic collapse. Under the terms of the $172 billion bailout,
Greece will reduce its debt to about 120.5 percent of its gross
domestic product by 2020, from about 160 percent in early 2012.
Banks that hold Greek bonds, which had agreed in October 2011 to
take a 50 percent loss on the face value of their bonds, agreed in
February 2012 to take a 53.5 percent loss on the face value, the
equivalent of an overall loss of around 75 percent.
On March 30, 2012, the Spanish government announced an annual
budget that includes €17.8 billion ($24 billion) in fresh
spending cuts for the central government, one day after it faced a
nationwide general strike and said it would continue its
increasingly unpopular austerity drive. Shortly afterward, Spain,
which faces record unemployment of more than 25 percent, officially
joined seven other eurozone nations in recession. Spain's
credit rating was cut by S&P to just above "junk"
status in June 2012, setting the stage for yet another eurozone
rescue. Shortly afterward, Spain agreed to accept a bailout of up
to €100 billion ($125 billion) for its cash-starved banks.
Spanish and Portuguese workers coordinated a general strike in
November to protest continued austerity measures.
On May 6, 2012, in a popular backlash against austerity measures,
voters in France ousted the pro-austerity administration of Nicolas
Sarkozy and elected François Hollande as the first Socialist
president of France since 1995.
Official figures released by the British government at the end of
April 2012 indicated that Britain fell into its first double-dip
recession since the 1970s, raising more questions about whether
government belt tightening in Europe has gone too far. Near the end
of 2012, George Osborne, Britain's Chancellor of the Exchequer
and the architect of the nation's austerity program, informed
Parliament that the government missed one of its self-imposed
debt-cutting goals and will have to extend the belt tightening into
2018, a year longer than previously promised.
In July 2012, the Italian government approved €4.5 billion
($5.6 billion) in spending cuts for 2012 aimed at slashing the size
of Italy's bloated public sector and delaying a new tax
increase until after the first half of 2013.
A positive development in the European debt crisis came on December
13, when EU leaders agreed to place eurozone banks under a single
supervisory authority. The agreement would put between 100 and 200
major banks under the direct oversight of the European Central
Bank, leaving thousands of smaller institutions to be overseen
principally by national regulators. The new system is designed to
strengthen oversight of a sector that, under the supervision of
national regulators, failed to prevent banks from amassing debt
quantities that could endanger the finances of eurozone states and
threaten the future of the currency. The supervision mechanism is
to be fully operational by March 2014 and is subject to the
approval of the European Parliament and national legislatures
before it goes into effect.
Asia
Short-term growth nearly ground to a halt in India during 2012,
dampening hopes that India, along with China and other non-Western
economies, might help revive the global economy, as happened after
the 2008 financial crisis. India is now facing a political
reckoning, as the country's elected leaders address difficult,
politically unpopular decisions. India's currency (the rupee)
is falling, investment is down, inflation is rising, and deficits
are eroding government coffers.
Faced with a sharply slowing Chinese economy, weak exports, and
faltering investment, China's central bank unexpectedly
announced in June 2012 that it would cut interest rates by a
quarter of a percentage point. The interest-rate cut was the first
by the central bank since December 2008, the last time policymakers
in China—the world's second-largest economy—were
deeply worried that they might be behind in responding to an
economy receding faster than expected.
After three decades of torrid growth, China is encountering an
unfamiliar problem with its newly struggling economy: a huge
buildup of unsold goods that is cluttering shop floors, car
dealerships, and factory warehouses. The glut of everything from
steel and household appliances to cars and apartments is hampering
China's efforts to emerge from a sharp economic slowdown. China
is also confronting a major change in political leadership, with
the election in November 2012 of Xi Jinping to the post of General
Secretary of the Communist Party.
The world's third-largest economy also found itself treading
water in 2012. In February 2012, Japan posted a record trade
deficit, as the yen's strength and weaker global demand eroded
profits at manufacturers and slowed the nation's recovery from
the earthquake and tsunami in 2011. The trade gap widened to
¥1.48 trillion ($19 billion), and shipments dropped 9.3 percent
compared with 2011, as energy imports surged.
On February 27, 2012, Elpida Memory, Inc., the last Japanese maker
of computer-memory chips, sought bankruptcy protection, with
liabilities of ¥448 billion ($5.5 billion). The company's
failure to embrace the global consumer shift from computers to
smartphones and tablets pushed the chipmaker into bankruptcy. This
bankruptcy is the nation's largest since Japan Airlines Co.
sought protection in January 2010 with ¥2.32 trillion in
liabilities.
Sony Corporation more than doubled its projected net loss in 2012
to ¥520 billion, the worst ever, as additional tax expense hurt
a company already battered by heavy losses in its television
business, a strong yen, and natural disasters in Japan and
overseas. It later announced a reduction in its global labor force
of 10,000 employees (6 percent of its workers).
A Good Year in the Markets
Despite stalled U.S. economic growth, fiscal deadlock in
Washington, an intensifying European debt crisis, and a slowdown in
China, Japan, and India, stock markets had a surprisingly good year
in 2012. In the U.S., the Dow Jones Industrial Average, the S&P
500, and the NASDAQ Composite Index all ended 2012 substantially
higher, despite losing some ground in the final days of the year as
concerns about the looming "fiscal cliff" mounted. Stocks
staged a late-day rally in the final session of 2012, enabling the
Dow Jones Industrial Average to post a 7.3 percent gain for the
year, as hopeful investors wagered that politicians would come up
with a last-minute resolution to avert the impending crisis. The
Dow rose 166.03 points on December 31, or 1.3 percent, to
13,104.14, marking the largest gain on the final day of the year in
its history. The S&P 500 Stock Index jumped 13 percent in 2012,
and the technology-heavy NASDAQ soared 16 percent during the
year.
In 2012, unlike in 2011, nearly all European and Asian markets
finished the year significantly higher. In Asia, Japan's Nikkei
225 was up more than 26 percent, with the Hong Kong Hang Seng Index
up more than 24 percent. In Europe, the Deutsche Börse AG
German Stock Index ("DAX") soared over 27 percent for the
year, the EURO STOXX 50 Price Index finished up more than 15
percent, and London's FTSE 100 Index was up more than 7
percent.
World markets were buoyed by the European Central Bank's
announcement on September 6 of a sweeping new program for buying
the bonds of troubled eurozone countries, followed by the U.S.
Federal Reserve's announcement on September 13 that the bank
would start a third round of its "quantitative easing"
bond-purchase program ("QE3") intended to push
longer-term interest rates lower and encourage borrowing and
investment.
Highlights of 2012
Top 10 Bankruptcies of 2012
In 2012, unlike in many previous years, when bank holding and
financial-services companies undone by the financial crisis
dominated the Top 10 List for public-company bankruptcy filings,
only a single financial-services company and two banking entities
made the year's Top 10. The remainder of the list was populated
by companies in the imaging, energy, publishing, aircraft, and
shipping industries. Each company on the Top 10 List checked into
chapter 11 with both assets and liabilities exceeding $1
billion.
Minneapolis, Minnesota-based real estate finance company
Residential Capital, LLC ("ResCap") grabbed the brass
ring for the largest public bankruptcy case in 2012 when it filed
for chapter 11 protection on May 14 in New York with $15.7 billion
in assets and $15.3 billion in debt. ResCap is a wholly owned
subsidiary of GMAC Mortgage Group, LLC, which in turn is wholly
owned by Ally Financial Inc. ("Ally"), the former finance
arm of General Motors Co. once known as GMAC. As one of the biggest
subprime-mortgage lenders in the country, ResCap was hit especially
hard by the financial crisis. The fallout from the crash swamped
both ResCap and Ally with mortgage liabilities—to the extent
that Ally is now 74 percent owned by the U.S. government after a
series of bailouts and failed the most recent round of bank stress
tests conducted by the U.S. Federal Reserve.
ResCap's long-awaited bankruptcy filing was intended to
alleviate that pressure (and enhance the prospects for taxpayer
recovery) by effecting a sale of the company's mortgage
business and loan portfolio. On November 21, 2012, the bankruptcy
court approved the sale of ResCap's mortgage business to Ocwen
Financial Corp and Walter Investment Management Corp., which agreed
to pay $3 billion in an auction. It also approved the sale of a
ResCap loan portfolio to Warren Buffett's Berkshire Hathaway
Inc., which agreed to pay $1.5 billion for a package of 50,000
loans. U.S. taxpayers are still owed nearly $12 billion from the
Ally bailout.
Santa Ana, California-based coal, natural gas, and wind power
producer Edison Mission Energy ("Edison Mission") surged
into the No. 2 position on the Top 10 List for 2012 when it filed a
prenegotiated chapter 11 case in Illinois on December 17 with $8.3
billion in assets. Through its subsidiaries, Edison Mission sells
or trades energy from coal-fired generating facilities, natural
gas-fired generating facilities, and renewable energy facilities,
including one of the largest portfolios of wind projects in the
U.S. The company has suffered financial losses amid low energy
prices, high fuel costs, relatively weak power demand, and low
power generation at coal-fired plants run by Midwest Generation, an
Illinois-based subsidiary. Edison Mission is a subsidiary of Edison
International, which did not file for bankruptcy. Prior to the
chapter 11 filing, Edison International reached an agreement with
Edison Mission and the majority of Edison Mission's noteholders
whereby ownership of Edison Mission will be transferred to
creditors, subject to bankruptcy-court approval.
The No. 3 spot on the Top 10 List for 2012 was captured by iconic
imaging pioneer Eastman Kodak Company ("Kodak"), which
filed for chapter 11 protection in New York on January 19, 2012,
with $6.24 billion in assets and $7.3 billion in debt. At the time
of the filing, the Rochester, New York-based company was running
short of cash and unable to sell 1,100 digital-imaging patents that
could have forestalled a bankruptcy filing. Kodak, the company that
invented the digital camera nearly 40 years ago and whose late
19th-century rise to prominence and later ubiquity were owing to
the technical and marketing genius of founder George Eastman, never
successfully transitioned from its reliance on the
photographic-film business, despite the increasing dominance of
newer imaging technologies. Kodak had 17,000 employees worldwide
and 8,000 in the U.S. (principally in Rochester) at the time of the
filing. At its peak in the early 1980s, the company employed 62,000
people in Rochester and 130,000 worldwide. On January 11, 2013, the
bankruptcy court approved the sale of Kodak's 1,100
digital-imaging patents for $527 million to a consortium that
included Apple Inc., Microsoft Corp., Google Inc., Adobe Systems
Inc., Research In Motion Ltd., Samsung Electronics Co., Fujifilm
Corp., and Facebook Inc. The sale is a key element of the
company's plans to shift its focus to commercial packaging and
printing from photography.
Overseas Shipholding Group Inc. ("OSG"), one of the
world's largest publicly traded tanker owners, berthed in the
No. 4 position on the Top 10 List for 2012 when it foundered into
chapter 11 in Delaware, along with 180 affiliates, on November 14,
2012, listing more than $4 billion in assets and $2.7 billion in
debt. OSG owns or operates 111 vessels that transport oil, refined
products, and natural gas worldwide. OSG and other crude oil
shippers have been buffeted in recent years by slowing demand for
oil, combined with a sharp fall in shipping rates for international
crude and product vessels. In addition, OSG has ongoing tax
problems that rendered its last three years of financial statements
unreliable and created a potential for default under its loan
agreements.
St. Louis, Missouri-based Patriot Coal Corp. ("Patriot")
excavated its way into the No. 5 spot on the Top 10 List for 2012
when it filed for chapter 11 protection on July 9, 2012, together
with 98 affiliates in New York, listing $3.8 billion in assets and
$3.1 billion in debt. Patriot produces and markets coal products in
the eastern U.S., with operations and coal reserves in the
Appalachian and Illinois Basin coal regions. The company struggled
in recent years because of decreased demand for coal, due largely
to an increase in natural gas and other energy sources. At the same
time, Patriot's liabilities increased because of rising costs
due to "more burdensome environmental and other
regulations" as well as "unsustainable labor-related
legacy liabilities." In addition, due to an adverse court
ruling, Patriot is obligated to build water-treatment facilities
that will cost hundreds of millions of dollars. On November 27,
2012, the bankruptcy court in New York ordered venue of
Patriot's chapter 11 cases to be transferred to Missouri, where
Patriot's corporate headquarters and executive offices are
located.
Houston, Texas-based ATP Oil & Gas Corporation
("ATP"), which acquires, develops, and produces oil and
natural gas assets in the Gulf of Mexico, the North Sea, and the
Mediterranean, drilled its way into the No. 6 position on the Top
10 List for 2012 when it filed for chapter 11 protection in Texas
on August 17, 2012, listing $3.4 billion in assets and $3.1 billion
in debt. Prior to its bankruptcy filing, ATP had estimated net
proved reserves of 118.9 million barrels of crude oil equivalent
and 241.5 billion cubic feet of natural gas. ATP stated that it
filed for chapter 11 to manage debt it incurred because of the
five-month moratorium on most U.S. offshore drilling after the
deadly 2010 Gulf of Mexico oil spill.
First Place Financial Corp. ("FPF"), the bank holding
company for First Place Bank, was deposited into the No. 7 position
on the Top 10 List for 2012 when it filed for chapter 11 protection
in Delaware on October 28, 2012. Based in Warren, Ohio, First Place
Bank was a federally chartered stock savings association with more
than 40 branches in Ohio, Michigan, Indiana, and Maryland. On
October 26, 2012, FPF entered into an agreement to sell First Place
Bank to Talmer Bancorp ("Talmer") as a means of complying
with certain directives issued by the Office of the Comptroller of
the Currency and the Office of Thrift Supervision ("OTS")
(which merged on July 21, 2011). The bankruptcy court approved the
sale of First Place Bank to Talmer on December 14, 2012. Although
FPF's most recent public financial statements showed $3.2
billion in assets, the company listed only $175 million in assets
and $64.5 million in debt in its bankruptcy filings.
Hawker Beechcraft, Inc. ("Hawker") crash-landed into the
No. 8 spot on the Top 10 List for 2012 when it filed for chapter 11
protection in New York on May 3, 2012, with $2.8 billion in assets
and $3.7 billion in debt. Wichita, Kansas-based Hawker manufactures
business, special mission, and trainer/attack aircraft as well as
parts and aviation products. At the time of the filing, the company
had 5,400 employees and 100 service centers supporting a fleet of
34,000 aircraft. Hawker was formed in 1994 when Raytheon Company
merged its Beech Aircraft Corporation and Raytheon Corporate Jets
units. In 2006, Raytheon sold Hawker to Goldman Sachs and Onex
Corporation, leaving the company with a heavy debt burden that it
struggled to support from the 2008 economic crisis onward. Hawker
filed for chapter 11 protection after defaulting on interest
payments.
In July 2012, the Chinese company Superior Aviation Beijing offered
to purchase Hawker for $1.79 billion, but the deal fell through in
October 2012 due to a combination of regulatory concerns and labor
issues. In early November 2012, Hawker announced that it would lay
off more than 400 of its remaining workers, close various service
facilities, and trim its business operations to concentrate on its
core manufacturing and maintenance activities. Hawker later filed a
chapter 11 plan proposing a restructuring pursuant to which it
would emerge from bankruptcy under a new name, Beechcraft
Corporation, with significantly scaled-back operations and $525
million in exit financing.
Textbook publisher Houghton Mifflin Harcourt Publishing Company
("Houghton Mifflin") booked position No. 9 on the Top 10
List for 2012 when it and 20 affiliates filed prenegotiated chapter
11 cases in New York on May 21, 2012, listing $2.7 billion in
assets and $3.5 billion in debt. Boston-based Houghton Mifflin
publishes textbooks used at all grade levels. It also publishes
novels, nonfiction books, children's books, and reference
works, including such classics as J.R.R. Tolkien's The Lord of
the Rings and H.A. and Margret Rey's Curious George books for
children. The company's educational software unit developed
popular computer games such as "The Oregon Trail."
Houghton Mifflin struggled financially for years, laden with debt
taken on when Education Media and Publishing Group, an Irish
private-equity concern, borrowed heavily to finance the
acquisitions of Houghton Mifflin in 2006 and Harcourt in 2007.
Venue of the chapter 11 cases was transferred to Massachusetts, but
only after the bankruptcy court in New York confirmed a chapter 11
plan for Houghton Mifflin on June 21, 2012, effectively ending the
company's 32-day stay in bankruptcy. Under the plan, Houghton
Mifflin swapped its existing bank and bond debt for 100 percent of
the equity in the restructured company.
The final spot on the Top 10 List for 2012 belongs to United
Western Bancorp, Inc. ("UW Bancorp"), a Denver-based
holding company that owned United Western Bank until January 21,
2011, when the Federal Deposit Insurance Corporation was appointed
receiver for the bank by OTS and oversaw the sale of the bank's
eight branches to First-Citizens Bank & Trust Company of
Raleigh, North Carolina. UW Bancorp responded by suing OTS,
claiming that the seizure was an abuse of power. UW Bancorp filed
for chapter 11 protection in Colorado on March 2, 2012. Although
the company's most recent public financial statements listed
$2.5 billion in assets, UW Bancorp scheduled assets valued at no
more than $10 million in its bankruptcy filings.
Other notable debtors (public and private) in 2012
included:
Hostess Brands, Inc. ("Hostess"), the iconic baker of Wonder Bread, Twinkies, and HoHos, which filed for chapter 11 protection for the second time in a decade (Hostess was known as Interstate Bakeries at the time of its 2004 chapter 11 filing) in New York on January 11, 2012, citing soaring costs and weakened demand for its products. Founded in 1937 and based in Irving, Texas, privately held Hostess had 18,500 employees, 33 bakeries, 565 distribution centers, and nearly $1 billion in assets at the time of the filing. On November 16, 2012, one week after one of its biggest unions went on strike to protest a labor contract, 82-year-old Hostess announced plans to wind down operations and sell its portfolio of well-known brands.
LightSquared Inc. (f.k.a. SkyTerra Communications), a privately owned telecommunications company that filed for chapter 11 protection in New York on May 14, 2012, listing $4.5 billion in assets after its plan to deliver high-speed wireless to as many as 260 million people ran afoul of U.S. regulators.
Houston, Texas-based Dynegy Inc., a privately owned company whose subsidiaries produce electric energy from 16 coal- and gas-fired power facilities located in six states, which filed for chapter 11 protection on July 6, 2012, in New York, listing $4.1 billion in assets. The filing was part of a settlement agreement with creditors involving a merger of Dynegy, Inc., with its largest subsidiary, Dynegy Holdings (which had filed for chapter 11 on November 7, 2011), and the sale of Dynegy, Inc.'s remaining assets to satisfy creditor claims.
Arcapita Bank BSC (f.k.a. First Islamic Investment Bank) ("Arcapita"), a Bahrain-based privately owned manager of Islamic-compliant (Shari'ah-compliant) investments with $7 billion under management, which filed for chapter 11 protection in New York, listing $3 billion in assets and $2.6 billion in debt after failing to reach an agreement with creditors on the refinancing of a $1.1 billion syndicated Shari'ah-compliant loan. In December 2012, the bankruptcy court overseeing Arcapita's chapter 11 case authorized the first-ever Shari'ah-compliant debtor-in-possession financing.
Pinnacle Airlines Corp., a Memphis-based regional air carrier that operates a jet and turboprop fleet under agreements with Delta Air Lines, Inc., United Continental Holdings, Inc., and US Airways Group, Inc., which filed for chapter 11 protection on April 1, 2012, in New York, listing $1.5 billion in assets and $1.4 billion in debt.
The City of Stockton, California, which became the largest city in U.S. history to seek bankruptcy protection when it filed a chapter 9 petition on June 28, 2012, in California to manage a $26 million budget deficit. The filing came after a breakdown in negotiations with creditors in compliance with A.B. 506, a newly effective California law that allows municipalities in financial distress to negotiate with creditors to restructure debts and agreements to avoid filing for bankruptcy. In its bankruptcy filings, Stockton listed assets of more than $1 billion and liabilities of more than $500 million.
The City of San Bernardino, California, 65 miles east of Los Angeles and home to about 210,000 residents, which became the third California city to file for bankruptcy protection in 2012 when it filed a chapter 9 petition on August 1, listing assets and liabilities in excess of $1 billion. In late July, San Bernardino reported that it had $56 million in debt payable from its general fund, including payments on a $50 million pension bond. The city also had $195 million in unfunded pension obligations, $61 million in unfunded retiree health care, and $40 million in workers' compensation and general liabilities.
A123 Systems Inc. ("A123"), a manufacturer of electric-car batteries and the recipient of nearly $250 million in U.S. government grants, which filed for chapter 11 protection on October 16, 2012, in Delaware, listing $626 million in assets, with a plan to sell its auto-business assets to auto-parts maker Johnson Controls Inc. ("Johnson"). However, previous suitor Wanxiang America Corp., the U.S. arm of Chinese auto-parts conglomerate Wanxiang Group, outbid Johnson, offering $257 million for the assets—more than doubling Johnson's initial offer. The bankruptcy court approved the sale to Wanxiang on December 11, but Johnson appealed. A123's defense-related business assets will be sold separately for $2.25 million to Navitas Systems.
Dewey & LeBoeuf ("Dewey"), a private law firm crippled by financial miscues and partner defections, which filed for chapter 11 protection on March 28, 2012, in New York, punctuating the largest law-firm collapse in U.S. history. Dewey unraveled after lower-than-expected profits—and debt mountainous by law-firm standards—forced it to slash partners' salaries. Already owed millions from previous years, the partners became concerned about Dewey's finances and eventually began a mass exodus that destroyed the firm. At its peak, Dewey employed more than 2,500 people, including roughly 1,400 lawyers in 26 offices across the globe.
Notable Bankruptcy Exits
Legislative/Regulatory Developments
Commission to Study Proposed Changes to Chapter
11
On April 19, 2012, a commission established by the American
Bankruptcy Institute (the "ABI Commission") to study the
reform of chapter 11 of the Bankruptcy Code held its first public
meeting in Washington, D.C. On July 2, the ABI Commission released
the names of nearly 130 corporate restructuring experts to serve on
one of 13 advisory committees. The ABI Commission expects to issue
a report of its recommendations in April 2014. It convened five
public hearings in 2012 and anticipates holding as many as seven
field hearings in 2013, with topics for discussion to include: (i)
employee benefits; (ii) labor and management and the treatment of
collective bargaining agreements; (iii) valuations; (iv) unsecured
trade credit; (v) safe harbors for derivatives; (vi) changes from
the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
and their effect on trade credit, landlords, and others; (vii)
governance of troubled companies; and (viii) entrenched
management.
Bankruptcy-Fee Guidelines Proposed
On November 2, 2012, the U.S. Trustee, a unit of the U.S.
Justice Department entrusted with overseeing bankruptcy cases,
proposed new guidelines for attorneys' fees in large chapter 11
cases (defined as debtors with at least $50 million in assets and
$50 million in liabilities). A previous proposal from 2011 was
roundly criticized by bankruptcy attorneys, some of whom deemed it
overreaching and out of touch. The new proposal, to take effect in
the summer of 2013, incorporates some changes suggested by
professionals, such as narrowing which chapter 11 cases are
affected, but includes other provisions deemed objectionable,
including a provision that would call for attorneys to submit
budgets estimating the cost and type of work they intend to
perform. The guidelines are not binding law but are likely to act
as a benchmark.
Amended Bankruptcy Rules
On April 23, 2012, the U.S. Supreme Court approved amendments to
the Federal Rules of Bankruptcy Procedure (the "Bankruptcy
Rules") that became effective on December 1, 2012. Several of
the amendments involve technical and conforming changes to
eliminate inconsistencies within the existing Bankruptcy Rules, as
well as changes designed to make the Bankruptcy Rules consistent
with the Federal Rules of Civil Procedure and the Federal Rules of
Appellate Procedure.
Additional amendments to the Bankruptcy Rules were proposed in
August 2012 by the Committee on Rules of Practice and Procedure of
the U.S. Judicial Conference, including a rule that would require
parties in all bankruptcy cases to consent to judgments issued by
bankruptcy courts to help eliminate confusion over court authority
in light of the U.S. Supreme Court's landmark 2011 decision in
Stern v. Marshall, 132 S. Ct. 56 (2011). The proposed amendments
would become effective December 1, 2014 (with certain
exceptions).
Stern v. Marshall Prompts New Court Rules/Orders
Several federal district courts have amended their standing
orders referring bankruptcy cases to bankruptcy courts in response
to Stern. Local-court rules have also been altered to account for
the decision. For example, the U.S. District Court for the Southern
District of New York issued an amended standing order of reference
on January 31, 2012, and the Local Rules Committee for the district
proposed new Local Bankruptcy Rules in response to Stern. Both
require litigants to state expressly whether or not they consent to
entry of final orders by bankruptcy courts in core proceedings if
the court is deemed to lack constitutional authority to enter a
final judgment or order. The U.S. District Court for the District
of Delaware similarly amended its standing order of reference on
February 29, 2012.
EC Insolvency Regulation Reform
On December 12, 2012, the European Commission ("EC")
proposed reforms to the EC Insolvency Regulation (Council
Regulation (EC) No 1346/2000) (the "EC Regulation")
designed to modernize the rules governing cross-border insolvency
proceedings. The preamble to the proposal states that "the new
rules will shift focus away from liquidation and develop a new
approach to helping businesses overcome financial difficulties, all
the while protecting creditors' right to get their money
back."
Key elements of the proposed reforms include: (i) broadening the
scope of the EC Regulation by revising the definition of
"insolvency proceedings" to include hybrid and
pre-insolvency proceedings, as well as debt-discharge proceedings
and other insolvency proceedings for natural persons; (ii) more
efficient administration of insolvency proceedings by: (a) giving
courts the discretion to deny a petition to commence a secondary
(nonmain) proceeding if it is deemed unnecessary to protect the
interests of local creditors, (b) abolishing the requirement that
secondary proceedings be winding-up proceedings, and (c) improving
coordination between main and secondary proceedings; and (iii)
enhanced public access to court decisions in cross-border
insolvency cases and standardization of creditor claim forms.
Italian Insolvency Act Amendments
Italian law decree No. 83 of June 22, 2012 (the
"Decree") introduced significant amendments to several
provisions of the Italian Insolvency Act governing: (a) a
debt-restructuring agreement (accordo di ristrutturazione dei
debiti) pursuant to Article 182-bis ("Art. 182-bis
Agreement"); and (b) an arrangement with creditors (concordato
preventivo) pursuant to Article 160 ("Arrangement with
Creditors"). Among other things, the Decree provides: (i)
easier access to an Arrangement with Creditors consistent with the
key principles underlying the chapter 11 process in the U.S.
Bankruptcy Code; (ii) a new form of Arrangement with Creditors
aimed at ensuring the continuity of an insolvent debtor as a going
concern (concordato con continuità aziendale); (iii)
enhanced protection of new financing granted in connection with
restructuring proceedings; and (iv) certain amendments to
provisions regulating the payment of dissenting creditors under an
Art. 182-bis Agreement.
French Insolvency Law Amendments
On September 20, 2012, the French government issued a decree
amending the requirements for the commencement of an accelerated
financial safeguard proceeding (procédure de sauvegarde
financière accélérée
("SFA")). An SFA combines the elements of a
"conciliation" (an out-of-court pre-insolvency proceeding
involving a court-appointed mediator widely used to restructure
distressed businesses in France) and a "safeguard"
proceeding, which is a court-supervised proceeding culminating in
the implementation of a plan restructuring a company's debt.
With the changes, an SFA may now be commenced by a solvent company
with either: (i) a balance-sheet surplus exceeding €25
million; or (ii) a balance-sheet surplus exceeding €10
million, provided it controls a company satisfying 150-employee or
€20 million-turnover thresholds. Thus, an SFA, which will
facilitate financial restructurings in distressed leveraged-buyout
scenarios, is now available to most holding companies.
Russian Bankruptcy Law Amendments
On July 28, 2012, Russian president
Vladimir Putin gave his imprimatur to Federal Law No.
144-FZ, which amends Russian bankruptcy, financial, and banking
legislation, with the goal of improving regulations governing asset
returns and interim management of insolvent banks. Among other
things, the amendments change Russian insolvency law to remove
executive compensation and bonuses from the list of priority claims
in cases involving insolvent companies. The new law, which took
effect in November 2012, amends regulations governing interim
administrations of financial and banking entities that have
forfeited their operational licenses. It also revises the powers of
the Russian federal deposit insurance agency.
Notable Business Bankruptcy Decisions of 2012
Allowance/Disallowance/Priority/Discharge of
Claims
"Key employee" retention plans proposed by bankrupt
companies have been subject to rigorous scrutiny since Congress
amended the Bankruptcy Code in 2005 to add section 503(c), which
makes it much more difficult to implement such programs. Several
notable court rulings were handed down in 2012 concerning the
propriety under section 503(c) of payments to key employees. Many
of these decisions concern the increasing frequency with which
chapter 11 debtors have characterized proposed payments to
personnel as a key employee incentive program ("KEIP"),
which is generally governed by the less stringent requirements of
section 503(c)(3), rather than as a key employee retention plan
("KERP"), which is strictly regulated by section
503(c)(1).
During 2012, several courts adopted the "business
judgment" standard applied to a proposed nonordinary-course
use, sale, or lease of estate property pursuant to section 363(b)
of the Bankruptcy Code as a litmus test for payments governed by
section 503(c)(3). See, e.g., In re Dewey & LeBoeuf LLP, 2012
WL 3065275 (Bankr. S.D.N.Y. July 30, 2012); In re Global Aviation
Holdings Inc., 478 B.R. 142 (Bankr. E.D.N.Y. 2012); In re Velo
Holdings Inc., 472 B.R. 201 (Bankr. S.D.N.Y. 2012).
In Velo Holdings, the court concluded that the chapter 11
debtors' proposed KEIP established incentive targets that,
although tied to the debtors' compliance with a
debtor-in-possession budget, required key employees to
"stretch" in order to qualify for plan payments, so as
not to constitute a retention plan subject to the restrictions set
forth in sections 503(c)(1) and (2). The court ruled that the
debtors met their burden of proving that the proposed KEIP was
primarily incentive-based as it related to key employees and that
implementation of the plan was a valid exercise of sound business
judgment under sections 363 and 503(c)(3).
In In re Hawker Beechcraft, Inc., 479 B.R. 308 (Bankr. S.D.N.Y.
2012), the court denied the debtor's motion to implement a KEIP
that would have paid bonuses of up to $5.3 million to a
"senior leadership team" and concluded that, although the
KEIP included elements of incentive compensation, "when viewed
as a whole, it set[] the minimum bonus bar too low to qualify as
anything other than a retention program for insiders."
In In re Residential Capital, LLC, 478 B.R. 154 (Bankr. S.D.N.Y.
2012), the court denied the debtors' bid to pay more than $7
million in bonuses to 17 top executives and ruled that the plan had
been improperly structured to ensure that top management would not
leave the company rather than to incentivize them to meet
performance goals. "Ultimately, the Debtors have failed to
carry their burden," the court wrote, pointing to a provision
that 63 percent of the bonus money could be earned simply by the
debtors' closing the sales of two loan portfolios that had been
substantially negotiated prepetition. However, the court later
approved the payments after the debtors made changes to the KEIP
designed to make it more incentivizing.
In In re Blitz U.S.A., Inc., 475 B.R. 209 (Bankr. D. Del. 2012),
the court concluded that a bonus plan proposed by the debtor was an
ordinary-course transaction, and therefore not subject to section
503(c), because the debtor had implemented similar plans for the
three years preceding its chapter 11 filing and because other
manufacturers had employed similar plans.
In keeping with courts' narrow construction of what constitutes
"substantial contribution" in a chapter 11 case within
the meaning of section 503(b)(3)(D) of the Bankruptcy Code, the
bankruptcy court in In re AmFin Financial Corp., 468 B.R. 827
(Bankr. N.D. Ohio 2012), denied administrative-expense priority to
the fees and expenses of senior noteholders, noting, among other
things, that "the efforts by the Senior Noteholders to settle
their own claims [were] not properly characterized as a substantial
contribution to the case."
In Machne Menachem, Inc. v. Spritzer (In re Machne Menachem), 2012
WL 8570 (3d Cir. Jan. 3, 2012), the Third Circuit, addressing the
power of a court to recharacterize debt as equity, affirmed a
bankruptcy court's ruling that certain advances made by a
purported lender to a not-for-profit debtor were not loans. The
bankruptcy court had looked to the intent of the parties as it
existed at the time of the transaction; analyzed the parties'
intent in keeping with the Third Circuit's earlier ruling in
Cohen v. K.B. Mezzanine Fund II (In re SubMicron Sys. Corp.), 432
F.3d 448 (3d Cir. 2006); and held that the advances were donations.
The Third Circuit ruled that the bankruptcy court's
determination was not clearly erroneous because: (i) "there
[was] no written instrument for the court to analyze and determine
whether the terms suggest[ed] an expectation of repayment,"
even though some of the checks had "loan" written on
them; and (ii) there was "no evidence of intent on behalf of
[the debtor] to accept or authorize the purported loans, such as a
resolution from the board of directors, or evidence that the board
was aware of the loans."
In Wright v. Owens Corning, 679 F.3d 101 (3d Cir. 2012), the Third
Circuit held that, although it had previously reversed the rule
stated in Avellino & Bienes v. M. Frenville Co. (In re M.
Frenville Co.), 744 F.2d 332 (3d Cir. 1984), governing when a
"claim" arises for purposes of discharge in bankruptcy,
due-process considerations mandated that the claims of certain
unknown defective-product claimants not be discharged—thereby
resuscitating Frenville's results in certain circumstances and
adding another layer of complexity to the analysis of discharged
claims.
In In re Heritage Highgate, Inc., 679 F.3d 132 (3d Cir. 2012), the
Third Circuit ruled that, in a chapter 11 reorganization, the term
"value," as applied to section 506(a), should mean the
fair market value of collateral as of plan confirmation. In so
ruling, the court of appeals rejected the market-based, or
"wait and see," approach recommended by a group of
secured creditors, whose subordinated claims would be rendered
unsecured unless the court included projected revenues from the
debtor's chapter 11 plan in the valuation analysis. Applying
the fair-market-value approach to calculate the amount of a
creditor's secured claim, the Third Circuit held, does not
constitute impermissible lien stripping. In addition, the court
adopted a burden-shifting approach to the question of who bears the
burden of demonstrating value.
In Statek Corp. v. Dev. Specialists, Inc. (In re Coudert Bros.
LLP), 673 F.3d 180 (2d Cir. 2012), the Second Circuit considered as
a matter of first impression which choice-of-law rules should apply
when a bankruptcy court sitting in one state is resolving a
bankruptcy claim arising from a state-law action previously filed
in another state. The court ruled that: (i) where a claim is wholly
derived from another legal claim pending in a parallel
nonbankruptcy proceeding in another state; and (ii) where the
pending original claim was filed in a court prebankruptcy, the
bankruptcy court must apply the choice-of-law rules of the state
where the underlying prepetition claim was filed (in this case,
Connecticut).
Avoidance Actions/Trustee's Avoidance and Strong-Arm Powers
In Senior Transeastern Lenders v. Official Committee of
Unsecured Creditors (In re TOUSA, Inc.), 680 F.3d 1298 (11th Cir.
2012), the Eleventh Circuit ruled that the bankruptcy court's
findings that subsidiaries of residential construction company
TOUSA, Inc., did not receive reasonably equivalent value in
exchange for liens they granted to secure financing to fund the
parent company's settlement with its joint-venture lenders were
not clearly erroneous. Accordingly, the Eleventh Circuit held,
those findings supported the bankruptcy court's determination
that the transaction was a fraudulent transfer under section
548(a)(1)(B) of the Bankruptcy Code. The TOUSA litigation has been
closely followed by the loan market because of the significant
implications for both lenders and borrowers when structuring loan
transactions with comparable structural features, such as upstream
guarantees with standard "savings clauses."
Reconciling discordant orders issued in the same chapter 11 case, a
Delaware bankruptcy court ruled in Industrial Enterprises of
America v. Burtis (In re Pitt Penn Holding Co., Inc.), 2012 WL
204095 (Bankr. D. Del. Jan. 24, 2012), that the two-year statutory
"look-back" period during which a fraudulent transfer may
be avoided pursuant to section 548 of the Bankruptcy Code cannot be
"equitably tolled."
Bankruptcy-Court Powers/Jurisdiction
Putting it mildly, the U.S. Supreme Court's 2011
ruling in Stern v. Marshall, 132 S. Ct. 56 (2011), cast a wrench
into the day-to-day operation of bankruptcy courts scrambling to
deal with a deluge of challenges—strategic or
otherwise—to the scope of their "core" authority to
issue final orders and judgments on a wide range of disputes. In
Stern, the Court ruled that, to the extent that 28 U.S.C. §
157(b)(2)(C) purports to confer authority on a bankruptcy court to
finally adjudicate a state-law counterclaim against a creditor that
filed a proof of claim, the provision is constitutionally invalid.
The mayhem among bankruptcy and appellate courts continued
throughout 2012.
In Onkyo Electronics v. Global Technovations Inc. (In re Global
Technovations Inc.), 694 F.3d 705 (6th Cir. 2012), the Sixth
Circuit became the first court of appeals to consider whether, in
the aftermath of Stern, a bankruptcy court has authority to enter a
final judgment in an action seeking to avoid a fraudulent transfer.
The Sixth Circuit held that the bankruptcy court did have authority
to do so because the creditor had filed a proof of claim. According
to the court, it was "crystal clear that the bankruptcy court
had constitutional jurisdiction under Stern to adjudicate whether
the sale [to the debtor of a subsidiary of Onkyo] was a fraudulent
transfer" because Onkyo's proof of claim could not be
resolved without addressing the fraudulent-transfer question. Thus,
the Sixth Circuit wrote, this "case is fundamentally unlike
[Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989)], where the
bankruptcy estate reached out to file a fraudulent-transfer claim
against a party who had filed no claim against the
estate."
However, the Sixth Circuit also stated that "[w]hat is not
crystal clear is whether the bankruptcy court had jurisdiction
under Stern to make the additional finding that Onkyo was a
'good-faith transferee' and a 'good-faith obligee'
under [the Florida Uniform Fraudulent Transfer Act]." The
bankruptcy court never reached the issue below because it
disallowed Onkyo's claim for the balance of the purchase price
in its entirety. The Sixth Circuit held that even though a
good-faith-transferee determination was not necessary to resolve
Onkyo's proof of claim, the bankruptcy court nonetheless had
authority to make the determination. According to the Sixth
Circuit, it did not read Stern to require a court "to
determine, in advance, which facts will ultimately prove strictly
necessary to resolve a creditor's proof of claim." Thus,
the mere possibility that a claim dispute will be resolved in a way
that requires the bankruptcy court to address unrelated matters
does not deprive the court of authority to issue a final
ruling.
The Sixth Circuit reprised its role as interpreter of Stern in
Waldman v. Stone, 698 F.3d 910 (6th Cir. 2012). In a surprising
ruling that reinvigorated the ongoing debate about Stern's
scope, the Sixth Circuit adopted a broad view of the case, holding
that the limitations imposed on bankruptcy courts by Article III of
the Constitution cannot be waived by a party's failure to
object at the trial-court level. In addition to rejecting the
waiver principle as a basis for bankruptcy courts to issue final
judgments in certain proceedings, the Sixth Circuit suggested that
a "statutory gap" in 28 U.S.C. § 157 may prevent a
bankruptcy court from issuing proposed findings of fact and
conclusions of law in core matters. The decision renewed
uncertainty regarding the constitutional limits of a bankruptcy
court to adjudicate both core and noncore claims.
In Executive Benefits Insurance Agency, Inc. v. Arkison (In re
Bellingham Insurance Agency, Inc.), 2012 WL 6013836 (9th Cir. Dec.
4, 2012), the Ninth Circuit ruled that, even though federal law
empowers bankruptcy judges to enter final judgments in
fraudulent-conveyance actions against a "nonclaimant"
(i.e., someone who has not filed a proof of claim), the U.S.
Constitution forbids entry of a final order because those claims do
not fall within the "public rights exception." However,
the court explained, defendants in such avoidance proceedings may
(and in this case did) consent to the entry of a final judgment by
the bankruptcy court, even if that consent was implied from the
defendant's failure to assert its right to entry of final
judgment by an Article III court. In addition, the Ninth Circuit
emphasized that a bankruptcy court may still hear and make
recommendations regarding any statutorily "core"
proceedings in which the court lacks the authority to enter a final
judgment.
In KHI Liquidation Trust v. Wisenbaker Builder Servs., Inc. (In re
Kimball Hill, Inc.), 480 B.R. 894 (Bankr. N.D. Ill. 2012), the
court suggested that bankruptcy courts do have the authority to
enter final judgments in both fraudulent-transfer and preference
litigation, whether or not: (i) the defendant filed a proof of
claim; (ii) the fraudulent-transfer and preference claims are
related to those initial claims; and (iii) the parties consented to
final adjudication by the bankruptcy court. The court concluded
that the vast majority of the Supreme Court's decision in Stern
(and the ruling in Ortiz v. Aurora Health Care, Inc. (In re Ortiz),
665 F.3d 906 (7th Cir. 2011), by which the Kimball Hill court was
bound), was mere dicta and therefore not controlling authority for
cases differing from the unique set of facts in Stern.
According to the Kimball Hill court, the proceeding before it did
not involve counterclaims and was in no way "steeped in state
law." Furthermore, the court wrote, it "[did] not share
anything in common with the proceedings that Stern and Ortiz held
[were] unconstitutional other than that they are all adversary
proceedings in a bankruptcy case," a commonality that was
"not sufficient to expand [Stern's] explicitly narrow
holding." The court remarked that "[a]s the right to
avoid a fraudulent transfer is steeped in bankruptcy law, the
bankruptcy court's entering final orders on the proceeding does
not chip away at the authority that the Constitution vested to the
Article III courts."
A Florida bankruptcy court ruled in In re Pearlman, 462 B.R. 849
(Bankr. M.D. Fla. 2012), that "substantive
consolidation"—the merging of the assets, liabilities,
and creditors of related entities—is purely a bankruptcy
remedy and that a bankruptcy court does not have the power to
consolidate the estate of a debtor in bankruptcy with the assets
and affairs of a nondebtor. In doing so, the court staked out a
position on a contentious issue that has created a widening rift
among bankruptcy and appellate courts regarding the scope of a
bankruptcy court's jurisdiction over nondebtor entities. For
example, in In re LLS America, LLC, 2012 WL 2042503 (B.A.P. 9th
Cir. June 5, 2012), a bankruptcy appellate panel affirmed a
bankruptcy-court order substantively consolidating the estates of
debtor and nondebtor entities without comment regarding the power
of the court to order the remedy.
In Continental Ins. Co. v. Thorpe Insulation Co. (In re Thorpe
Insulation Co.), 671 F.3d 1011 (9th Cir. 2012), the Ninth Circuit
ruled that a bankruptcy court has discretion, even in a
"core" proceeding, to decline to enforce an otherwise
valid and applicable arbitration provision, but only if arbitration
would conflict with the underlying purposes of the Bankruptcy
Code.
Chapter 11 Plans
In RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct.
2065 (2012), a unanimous U.S. Supreme Court upheld a ruling by the
Seventh Circuit denying confirmation of a "cramdown"
chapter 11 plan that contemplated the sale of encumbered assets
free and clear of all liens without giving a secured creditor the
right to credit-bid its claim in connection with the sale. By its
ruling, the Supreme Court resolved a circuit split on the proper
application of the "indubitable equivalent" prong of
section 1129(b)(2)(A) of the Bankruptcy Code.
In a prelude (and a corollary) to the highly anticipated ruling in
RadLAX, the Seventh Circuit in In re River East Plaza, LLC, 669
F.3d 826 (7th Cir. 2012), affirmed a bankruptcy court's ruling
that a debtor could not "cram down" a chapter 11 plan
over the objection of an undersecured creditor which had made a
section 1111(b) election by substituting a lien on 30-year U.S.
Treasury bonds as the "indubitable equivalent" of the
creditor's mortgage lien on the property.
"Mootness" is a doctrine that precludes a reviewing court
from reaching the underlying merits of a controversy. In federal
courts, an appeal can be either constitutionally or equitably moot.
Constitutional mootness is derived from Article III of the U.S.
Constitution, which limits the jurisdiction of federal courts to
actual cases or controversies and, in furtherance of the goal of
conserving judicial resources, precludes adjudication of cases that
are hypothetical or merely advisory. In contrast, "equitable
mootness" bars adjudication of an appeal when a comprehensive
change of circumstances occurs such that it would be inequitable
for a reviewing court to address the merits of the appeal. In
bankruptcy cases, equitable mootness is often invoked in an effort
to preclude appellate review of an order confirming a chapter 11
plan.
In In re Thorpe Insulation Co., 671 F.3d 980 (9th Cir. 2012),
amended and superseded on denial of rehearing en banc, 677 F.3d 869
(9th Cir. 2012), the Ninth Circuit, in a matter of first
impression, held that an appeal by certain nonsettling asbestos
insurers of an order confirming a chapter 11 case was not equitably
moot. According to the Ninth Circuit, the insurers used due
diligence in seeking a stay, the plan had not been substantially
consummated (as defined in section 1101 of the Bankruptcy Code),
remedies short of reversing confirmation would not inequitably
affect the interests of third-party asbestos claimants or a lender
that had extended credit to the reorganized debtor, and a remedy
could be fashioned for the insurers by a multitude of options other
than complete plan reversal.
In In re Philadelphia Newspapers, LLC, 690 F.3d 161 (3d Cir. 2012),
the Third Circuit held that the foremost consideration in ruling on
a challenge to plan confirmation on the basis of equitable mootness
is "whether allowing the appeal to go forward will undermine
the plan, and not merely whether the plan has been substantially
consummated." According to the Third Circuit, the district
court erred by: (i) finding equitable mootness relying only on the
plan's substantial consummation under the Bankruptcy Code's
definition; (ii) failing to perform an analysis of whether a ruling
favorable to the appellants would upset the confirmed plan; and
(iii) faulting the appellants for not seeking a stay, without
explaining whether a stay was critical, given the progression of
the debtors' bankruptcy cases.
In re Charter Communications, Inc., 691 F.3d 476 (2d Cir. 2012),
the Second Circuit deepened a split between the circuits with
respect to the standard of review and burden of proof to be applied
in equitable-mootness cases. The court held that once a chapter 11
plan has been substantially consummated, an appeal is presumed to
be equitably moot unless the appellant can demonstrate that it has
met all five of the criteria delineated in its previous ruling in
Frito-Lay, Inc. v. LTV Steel Co. (In re Chateaugay Corp.), 10 F.3d
944 (2d Cir. 1993). By appearing to abandon the balancing approach
employed by other circuits in this context, the Second Circuit now
stands alone in presuming that an appeal is equitably moot
following substantial consummation of a chapter 11 plan. This
deepening rift may be a compelling invitation to review by the U.S.
Supreme Court.
The strategic importance of classifying claims and interests under
a chapter 11 plan is sometimes an invitation for creative
machinations designed to muster adequate support for confirmation
of the plan. A prominent bone of contention in the ongoing
plan-classification dispute concerns the legitimacy of separately
classifying similar, but arguably distinct, kinds of claims in an
effort to create an accepting impaired class or to prevent a
dissenting creditor from dominating a class because its claim is so
substantial that the creditor can ensure that the class votes to
reject a plan. Sometimes referred to as class
"gerrymandering," this practice was the subject of a
ruling handed down by a bankruptcy appellate panel in In re Loop
76, LLC, 465 B.R. 525 (B.A.P. 9th Cir. 2012). The panel affirmed a
bankruptcy-court ruling that an unsecured-deficiency claim should
be classified separately from the claims of other unsecured
creditors because the undersecured creditor had recourse to a
guarantee for payment of its deficiency claim, such that the claims
were not substantially similar.
In In re 18 RVC, LLC, 2012 WL 5336733 (Bankr. E.D.N.Y. Oct. 22,
2012), the court ruled that the existence of a personal guarantee
for an unsecured claim of a partially secured lender is
insufficient to support separate classification of that claim under
section 1122(a) of the Bankruptcy Code as one that is not
"substantially similar" to all other unsecured claims.
The ruling was the first outside the Ninth Circuit to decline to
follow Loop. In doing so, the 18 RVC court agreed with the
reasoning articulated in In re 4th Street East Investors, Inc.,
2012 WL 1745500 (Bankr. C.D. Cal. May 15, 2012), the first decision
rejecting Loop, where the bankruptcy court held that the existence
of a nondebtor guarantee is an insufficient basis to separately
classify unsecured claims.
In Federal National Mortgage Assoc. v. Village Green I GP, 2012 WL
6045896 (W.D. Tenn. Dec. 5, 2012), the district court ruled that a
bankruptcy court improperly rejected outright the "doctrine of
artificial impairment," which refers to the manipulation of
classes of claims in order to artificially create an accepting
class of impaired claims. Reversing and remanding the decision
below, the district court concluded that the determining factor
should be not whether the impairment was artificial, but whether
the impairment was without justification. The court rejected the
majority view that artificial impairment "runs afoul" of
the requirements for chapter 11 confirmation, including sections
1129(a)(3) and 1129(a)(10).
In In re American Capital Equipment, LLC, 688 F.3d 145 (3d Cir.
2012), the Third Circuit held as a matter of first impression that
a bankruptcy court may, in certain circumstances, resolve
confirmation issues at the disclosure-statement hearing. The court
of appeals affirmed a bankruptcy court's ruling at the
disclosure-statement stage that: (i) a chapter 11 plan did not
satisfy the Bankruptcy Code's requirements that a plan be
"feasible" and proposed in "good faith"; and
(ii) the debtors' chapter 11 cases should be converted to
chapter 7 liquidations due to the plan's "patent
unconfirmability."
In In re Federal-Mogul Global Inc., 684 F.3d 355 (3d Cir. 2012),
the Third Circuit held that a debtor could assign insurance
policies to an asbestos trust established under section 524(g) of
the Bankruptcy Code, notwithstanding anti-assignment provisions in
the policies and applicable state law. Like the courts below, the
Third Circuit determined that it had already held in In re
Combustion Engineering, Inc., 391 F.3d 190 (3d Cir. 2004), that
section 1123 of the Bankruptcy Code preempts anti-assignment
provisions which would otherwise bar the transfer of insurance
rights to an asbestos trust. The Third Circuit rejected the
argument that section 1123's preemption scope should be based
on section 1142 of the Bankruptcy Code (providing that the debtor
shall implement the plan "[n]otwithstanding any otherwise
applicable nonbankruptcy law, rule, or regulation relating to
financial condition") and the Ninth Circuit's ruling in
Pac. Gas & Elec. Co. v. California ex rel. California Dept. of
Toxic Substances Control, 350 F.3d 932 (9th Cir. 2003). The court
saw no reason to read sections 1123 and 1142 coextensively. In
addition to finding Pacific Gas distinguishable, the Third Circuit
was "unconvinced" that sections 1123 and 1142 are so
similar that they must be read together.
In In re Caviata Attached Homes, LLC, 481 B.R. 34 (B.A.P. 9th Cir.
2012), the court considered as a matter of first impression whether
unforeseen circumstances prevented a chapter 11 debtor from
complying with the terms of a chapter 11 plan confirmed in a
previous chapter 11 case. Section 1127(b) of the Bankruptcy Code
prohibits the modification of a substantially consummated plan.
Even so, some courts have held that serial chapter 11 filings are
not per se impermissible and that a second plan may modify the
first plan where there has been an unforeseeable or unanticipated
change in circumstances.
In Caviata, the court considered an appeal from a bankruptcy-court
order dismissing a serial chapter 11 filing 15 months after
confirmation of a plan in the debtor's previous chapter 11
case. The appellate panel cautioned that "[e]ven extraordinary
and unforeseeable changes will not support a new Chapter 11, if
these changes do not substantially impair the debtor's
performance under the confirmed plan." It left undisturbed the
bankruptcy court's finding that a decline in the U.S. economy
between 2010 and 2011 was not an unforeseeable changed circumstance
that substantially impaired the debtor's ability to perform
under its confirmed chapter 11 plan.
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