In the last several months, there have been some significant legal developments that could impact acquisition finance. This article will survey some of the more notable ones.

In a case with implications for buyers of assets in a bankruptcy court-ordered sale under section 363(b) of the Bankruptcy Code, the Bankruptcy Court for the Southern District of New York recently issued a decision limiting the ability of manufacturers that are debtors in a bankruptcy case to sell assets free and clear of future liabilities.

In Olson v. Frederico,1 Ms. Frederico, a Federal Express employee, was injured when a truck she was driving crashed into a tree. The truck had been designed and manufactured by a predecessor of Olson, which had purchased the assets of the truck manufacturer in a section 363(b) bankruptcy court sale. The sale order had provided that such sale "shall be free and clear of all . . . claims . . . and other interests . . . whether arising prior to or subsequent to the commencement of this chapter 11 case." When Frederico initially sued Olson in state court on a products liability theory, Olson brought an action in the bankruptcy court to prohibit Ms. Frederico's state court action from proceeding, on the basis that her claim was barred by the bankruptcy court's sale order.

The bankruptcy court held that its prior sale order did not bar Frederico's claim against Olson, because Frederico had had no contact with the original manufacturer, and because Frederico could not have reasonably known, and had never been notified, that any such future claim of hers would be barred by the earlier sale order. The bankruptcy court stressed the concerns of practicality and due process, noting that due process in this situation would have required the court to provide notice reasonably calculated to reach relevant parties whose future claims would be barred, and afford them (or their representatives) opportunity to object.

Prospective purchasers of assets of a manufacturer in a bankruptcy sale will need to factor in to both the proposed purchase and any financing thereof the risk of future products liability claims arising after purchase of the assets in question, and may also wish to consider any related insurance issues.

In June, the Court of Appeals for the Seventh Circuit handed down a decision that created a split between it, on the one hand, and the Third and Fifth Circuit Courts of Appeal, on the other, regarding the ability of a debtor in a bankruptcy case to limit credit bidding by its secured creditors in an auction of its assets constituting collateral. In River Road Hotel Partners, LLC v. Amalgamated Bank,2 the debtors filed chapter 11 plans of reorganization that provided for an auction of substantially all of their assets. The bidding procedures motion submitted by the debtors in connection with the sale would have precluded secured creditors from credit bidding their claims in the auction. In so doing, the debtors relied on a Third Circuit decision, In re Philadelphia Newspapers,3 which had previously ruled that the Bankruptcy Code permits auction bidding procedures that prohibit secured creditors from credit bidding their claims, so long as the secured creditors otherwise receive the "indubitable equivalent" of the value of their collateral. Though the Third Circuit did not calculate the "indubitable equivalent" amount in the case it had decided, it noted that the total value received by the secured creditors, including cash, other compensation and additional collateral security, must generate a value that constitutes such "indubitable equivalent."

The Seventh Circuit disagreed and adopted the view of the dissent in Philadelphia Newspapers, ruling that the earlier decision was incorrect, and that "the Code does not appear to contain any provisions that recognize an auction sale where credit bidding is unavailable as a legitimate way to dispose of encumbered assets."

Subsequent to the Philadelphia Newspapers decision limiting secured creditors' rights to credit bid, many secured lenders responded by seeking to condition any use of cash collateral by the debtor and debtor-in-possession financing on the debtor's agreement to waive in advance any right to pursue an asset sale in the case that would preclude credit bidding. With the River Road decision favoring secured lenders and their right to credit bid, secured lenders now face a split among circuit courts on this important issue. The debtors have appealed the River Road decision to the United States Supreme Court.

The Bankruptcy Court for the Southern District of New York recently decided a case addressing the scope of certain exceptions to the avoidance powers of a trustee or debtor-in-possession in a bankruptcy case, addressing the avoidability of payments made to selling shareholders in a leveraged buyout transaction.

Section 546(e) of the Bankruptcy Code exempts from fraudulent transfer avoidance any "settlement payments" received on securities. In re MacMenamin's Grill Ltd.4 involved a small leveraged buyout of a bar and restaurant, which was insolvent at the time of the buyout. The trustee sought to avoid the acquisition financing and the payment of the proceeds to the selling shareholders as fraudulent transfers. The selling shareholders and lender moved for summary judgment, asserting that, as "settlement payments" on securities, the same were exempt from avoidance. The court, after reviewing the legislative history and noting recent judicial trends, held that the exemption was intended only for transactions effectuated through securities markets, where avoidance could prove disruptive to the functioning of such markets. The court held therefore that the exemption was not available in the context of the private transaction at issue in the case at hand, which was not effectuated through a securities market, and thus denied the motion for summary judgment.

Shortly after the MacMenamin's decision, the U.S. Court of Appeals for the Second Circuit handed down a decision in In re Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V.5 In that case, Enron had made a draw under its revolving credit facility to fund the paydown of certain of its commercial paper. The trustee in Enron's bankruptcy case sought to recover the repayments made on the commercial paper. The holders of the commercial paper asserted that the repayments were "settlement payments" on securities, exempt from avoidance under the Bankruptcy Code.

The Second Circuit agreed with the commercial paper holders, ruling that the repayments on the commercial paper were non-avoidable "settlement payments." The Second Circuit took a broad view of the "settlement payment" exemption, stating that it can apply to prepayments on and redemptions of, as well as transfers of title to securities. Further, the court noted in a nonbinding dictum that "undoing long-settled leveraged buyouts would have a substantial impact on the stability of the financial markets, even though only private securities were involved. . . ." Thus, in holding that the repayments to the commercial paper holders were not subject to avoidance, the court also hinted that its view of the exemption could be broad enough to potentially cover even payments such as those made to the selling shareholders in MacMenamin's.

We look forward to providing further updates on these and other matters in upcoming issues. Please feel free to contact us to discuss any of these items further.

Footnotes

1 Olson v. Frederico (in re Grumman Olson Indus., Inc.), 445 B.R. 243 (Bankr. S.D.N.Y. 2011).

2 In re River Road Hotel Partners LLC et al. and In re RadLAX Gateway Hotel LLC et al., 2011 WL 2547615 (7th Cir. 2011), consolidated into a single proceeding.

3 In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010).

4 In re MacMenamin's Grill, 2011 WL 1549056 (Bankr. S.D.N.Y. April 21, 2011).

5 In re Enron Creditors Recovery Corp., Case No. 09-5122 (C.A. 2, Jun. 28, 2011).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.