Bankruptcy Cases To Watch In The 2nd Half Of 2014

July 14, 2014

By Maria Chutchian

As 2014 stretches into its final half, bankruptcy professionals can expect clarification in several areas of uncertainty, including the full scope of bankruptcy courts’ powers, clawbacks against international investors, and how to approach a massive municipal insolvency.

The first half of the year brought a few decisions that left marks on bankruptcy law, including Executive Benefits Insurance Agency v. Arkison and a U.S. District Judge Jed S. Rakoff’s judgment in the Bernard L. Madoff Investment Securities LLC liquidation. But Executive Benefits failed to address the key question of whether parties in a dispute over a so-called “core” bankruptcy matter can consent to a workaround of the bankruptcy court system, and Rakoff’s decision on the role of international investors in a U.S. liquidation will undoubtedly be appealed, leaving room for additional rulings to determine their impact.

Influential decisions are also expected in cases surrounding the safe harbor provision of Section 546(e) of the U.S. Bankruptcy Code and in Detroit, the largest Chapter 9 case ever filed. Below are the issues bankruptcy attorneys should be keeping an eye on for the remainder of 2014.

The Validity of Consent

The U.S. Supreme Court‘s June decision in Executive Benefits held that bankruptcy courts could make tentative rulings in disputes deemed “core” under the Bankruptcy Code, which could then be sent to a federal district court for affirmation. But the court was decide whether or not parties in a dispute over a “core” matter can consent to the bankruptcy court making a final, binding ruling, therecircumventing traditional bankruptcy procedure.

“Ever since the Stern [v. Marshall] decision a couple years ago, that’s been an issue that’s caused a lot of havoc in the bankruptcy world,” Sam Stricklin of Bracewell & Giuliani LLP said. “Everyone thought that issue was going to be decided in Executive Benefits but they punted on it.”

The confusion could end soon, though. The justices recently agreed to hear Wellness International Network Ltd., which should clarify bankruptcy courts’ constitutional authority to enter final decisions on whether property in a debtor’s possession belongs to their bankruptcy estate.

WIN, a network marketing company, claimed that the Seventh Circuit misinterpreted Stern in its August ruling that found a bankruptcy court was wrong to declare a bankruptcy trust to be an alter ego of WIN’s former distributor Richard Sharif as a sanction for his failure to comply with discovery requests during his insolvency proceedings.

The 2011 Stern decision held that Congress’ grant of jurisdiction to bankruptcy courts to issue final judgments on counterclaims to proofs of claim was unconstitutional. Executive Benefits asked the court to determine whether or not so-called Stern claims can be determined a bankruptcy judge if the parties can make those final judgments if the parties agree.

“They neglected to rule on the issue because they found a way around it,” said Joseph O’Neil of Montgomery McCracken Walker & Rhoads LLP. “Based on the issues they certified, I don’t think they can do that again. They have to make a decision.”

WIN is represented Catherine Steege of Jenner & Block LLP.

Sharif is represented William J. Stevens of the Law Office of William J. Stevens.

The case is Wellness International Network et al. v. Richard Sharif, case number 13-935, in the Supreme Court of the United States.

Madoff Decision on Foreign Investors

On Monday, Judge Rakoff issued a decision preventing foreign investment funds from being forced to disgorge earnings from the Madoff fraud. His ruling rejected efforts to expand U.S. bankruptcy law overseas and effectively ended liquidating trustees’ ability to claw back funds from international investors in Ponzi schemes.

Experts say there will almost certainly be further litigation on the matter.

“Judge Rakoff says there’s a presumption against any statute having extraterritorial effect unless there is clear indication from Congress that it’s meant to have extraterritorial effect,” Matthew Gold of Kleinberg Kaplan Wolff & Cohen PC said. “So the argument on appeal will be that there will be some provisions of the Bankruptcy Code that are clearly meant to have a very broad application, including the definition of property of the estate.”

The judge held that the Bankruptcy Code’s avoidance and recovery mechanisms cannot be applied extraterritorially, rejecting BLMIS liquidating trustee Irving Picard’s claims that the statute allowed him pursue Madoff victim assets located in foreign banks.

The judgment hasn’t been appealed yet, though it’s expected to be. Picard will likely argue that general bankruptcy policy favors allowing trustees to broadly recover as much as they can so they can enhance the estate, Gold said.

“It could set some new precedent regarding clawback litigation,” Rosa Evergreen of Arnold & Porter LLP said.

The funds are represented by Sullivan & Cromwell LLPSkadden Arps Slate Meagher & Flom LLPSullivan & Worcester LLP,Cleary Gottlieb Steen & Hamilton LLP,Cravath Swaine & Moore LLPDebevoise & Plimpton LLPKelley Drye & Warren LLP,Paul Hastings LLPShearman & Sterling LLPSimpson Thacher & Bartlett LLP and Willkie Farr & Gallagher LLP.

Picard is represented by BakerHostetler,Windels Marx Lane & Mittendorf LLP and Young Conaway Stargatt & Taylor LLP.

The case is Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, case number 1:12-mc-00115, in the U.S. District Court for the Southern District of New York.

546(e)’s Safe Harbor Provision

Over the last several months, a handful of cases have hacked away at Section 546(e) of the Bankruptcy Code, which prevents trustees from throwing out settlements between banks and the debtors labeling them fraudulent or preferential transfers.

The bankruptcies of Lyondell Chemical Co., Tribune Co. and SemGroup LP have thrown into question the statute’s applicability in slightly different situations – for example, if a creditor rather than the trustee sues to void payments made to shareholders through a leveraged buyout.

The Lyondell and Tribune courts held that 546(e) applies only to the trustee and not applicable to claims brought or on behalf of individual creditors. The SemGroup judge, on the other hand, offered a conflicting interpretation, saying Section 546(g) – which applies to swap claims rather than settlement payments – impliedly prohibits liquidating trustees from asserting fraudulent transfer claims on behalf of creditors.

Experts say that debate will continue with arguments coming up in the SemGroup trustee’s dispute with Barclays Bank PLC and Tribune’s spat with its unsecured creditors, both of which are pending before the Second Circuit.

“[The focus will be on] the interplay between the Bankruptcy Code and the financial market. To what extent does the 546(e) safe harbor protect shareholders?” Evergreen said.

The cases are In re: Tribune Company Fraudulent Conveyance Litigation, case numbers 13-399213-387513-4178 and 13-4196, in the U.S. Court of Appeals for the Second Circuit and Bettina M. Whyte v. Barclays Bank PLC et al., case number 13-2653, in the U.S. Court of Appeals for the Second Circuit.

The Detroit Dilemma

Detroit’s $18 billion bankruptcy has presented the municipal restructuring community with an unprecedented situation that will presumably set the stage for future Chapter 9 cases, even if they aren’t as large-scale as Detroit’s.

A confirmation trial for Detroit’s proposed plan of adjustment is set for August after being delayed a couple of times. The result of the creditors’ votes for and against the plan are expected to be announced in the coming days.

The city has reached settlements with many of its key stakeholders, including unions, pension funds and bondholders. A few holdouts remain, though, most notably a group of bondholders owed around $1.5 billion who are set to receive less than 10 cents on the dollar. Syncora Guarantee Inc., their monoline insurer, has emerged as Detroit’s fiercest challenger loudly protesting the plan’s treatment of those bondholders.

If Detroit is able to successfully implement its plan to reinvest in its city’s services slashing its debt and accepting around $816 million from foundations, the state and other donors, the case will serve as a blueprint for other debt-ridden municipalities. The city has already overcome legal challenges to its eligibility for Chapter 9 protection, though that feat has not yet moved many others to seek bankruptcy just yet.

“We’re going to potentially see law being shaped through the confirmation process and in how a large Chapter 9 case like this is handled,” Evergreen said.

Detroit is represented Robert S. Hertzberg and Deborah Kovsky-Apap of Pepper Hamilton LLP and Corinne Ball, Thomas F. Cullen Jr., Gregory M. Shumaker and Geoffrey S. Stewart of Jones Day.

Syncora is represented Stephen M. Gross, David A. Agay and Joshua Gadharf ofMcDonald Hopkins LLC and Christopher Landau, James H.M. Sprayregen, Ryan Blaine Bennett and Stephen C. Hackney ofKirkland & Ellis LLP.

The case is City of Detroit, case number2:13-cv-14305, in the U.S. District Court for the Eastern District of Michigan.

–Editing Elizabeth Bowen and Katherine Rautenberg

Copyright Law360 2014. Reprinted here with permission.