Posts by: Distressed Debt and Investments Team

Plaintiffs Cannot Claim Creditor Status Retroactively

 

The Fifth Circuit Court of Appeals reminded the plaintiff that standing is “determined as of the commencement of the suit” and post filing claims purchases will not suffice to establish standing. Here, the plaintiff, [also the debtor’s owner], sought to appeal appointment of special counsel. The Bankruptcy Court found that the plaintiff lacked standing to object because he was not a creditor and did not have a stake in the estate and then approved the Trustee’s application to employ SBPC over the improper objection. The plaintiff filed an appeal and then purchased a proof claim in order to obtain creditor status. The Fifth Circuit agreed with the Bankruptcy Court and noted that “[o]nly those directly, adversely and financially impacted by a bankruptcy order may appeal it.” Standing is “determined as of the commencement of the suit and a plaintiff cannot belatedly claim creditor status and establish standing retroactively.”

Ninth Circuit Holds Protecting a Claim To Its Fullest Extent Is Not Evidence of Bad Faith

 

The Ninth Circuit Court of Appeals recently held that a secured creditor’s purchase of general unsecured claims to block confirmation of a Chapter 11 plan did not in itself constitute bad faith. In In re Fagerdala USA, the debtor owned real property on which Pacific Western Bank held the senior secured claim. The debtor’s plan of reorganization sought to impair Pacific Western’s claim by using an interest rate lower than the penalty interest rate for its loan, and modifying the length of the term and other loan provisions. Under section 1129(a)(10) of the Bankruptcy Code, in order to approve a plan over the objections of impaired creditors, a debtor is required to obtain the consent of at least one impaired class. In order to ensure that this debtor would not receive such consent, Pacific Western attempted to strategically buy up a sufficient amount of general unsecured claims—the only other impaired class—to block the plan. While Pacific Western did not seek to buy every general unsecured claim, it was able to purchase “one-half in number” of the general unsecured class, and was thus able to block the approval of the plan.

After the plan vote, the debtor moved to designate the votes Pacific Western cast on behalf of its general unsecured claims, arguing that Pacific Western purchased those claims in bad faith. To “designate” means the votes for the claims will not be counted in voting to accept or reject the plan. The bankruptcy court granted the debtor’s motion, concluding that “designation is appropriate in this case because [Pacific Western] will have an unfair advantage over the unsecured creditors who did not receive a purchase offer and who hold the largest percentage of claims…in terms of amount.” The district court affirmed this ruling, but the Ninth Circuit reversed it and remanded the case to the bankruptcy court.

The Ninth Circuit reasoned that “merely protecting a claim to its fullest extent cannot be evidence of bad faith. There must be some evidence beyond negative impact on other creditors.” Looking to case law, the court enumerated several clear examples of bad faith such as where a competitor purchases claims to destroy the debtor’s business or further its own or a non-preexisting creditor purchasing claims only to block the plan and then stated “[d]oing something allowed by the Bankruptcy Code and case law, without evidence of ulterior motive, cannot be bad faith. Not offering to purchase all the claims in a class (to later use those claims to block a plan) is not—alone—sufficient to evidence the bad faith necessary to designate votes under § 1126(e).”

Diligence Deferred Is A Transfer Denied

The Delaware Bankruptcy Court recently voided the transfer of bankruptcy claims where the seller failed to obtain the debtor’s prior written consent, as required by the underlying promissory notes.

Both the promissory notes and the related loan agreement included anti-assignment language providing that any transfer would be null and void unless the debtor provided its prior written consent. In spite of this restriction, the note holders transferred the notes to buyer without obtaining the debtor’s consent. When buyer filed a proof of claim based on the transferred notes, the debtor objected, arguing that the transfer was null and void because the debtor never consented.

Buyer first argued that the anti-assignment clause could not invalidate the transfer as a matter of Delaware law. In holding to the contrary, the court distinguished between anti-assignment clauses that merely limit a party’s “right” to assign from clauses that limit a party’s “power” to assign. Delaware courts will invalidate transfers under a contract where such contract includes an anti-assignment clause that provides any assignment made in violation of the clause will be null and void (e.g. limitation of “power” to assign), but will not invalidate transfers where the contract’s anti-assignment clause does not so provide (e.g. limitation of “right” to assign). The court held that the anti-assignment clauses in Woodbridge properly restricted the noteholders’ power to assign the notes because they provided for voiding any transfer made in violation thereof. Thus, invalidation of the transfers pursuant to the anti-assignment clauses was proper.

Buyer next argued that the anti-assignment clauses unenforceable either because of debtor’s breach of the agreement or because of UCC §9-408. The court disagreed holding “it is axiomatic that a non-breaching party may not emerge post-breach with more rights than it had pre-breach.” Accordingly, the anti-assignment clause remained attached to the promissory notes because “neither the [assignors] nor any assignee were able to emerge post-breach with more rights than they had pre-breach.” The Court then found UCC §9-408, which invalidates provisions restricting assignment in grants of security interests, inapplicable because Contrarian was not granted a security interest in the promissory notes.

Buyer then asserted that even if the anti-assignment clauses were both valid and enforceable they did not apply because the noteholders only transferred their rights under the notes and not the notes themselves. The court disagreed holding that “[t]he language of both the Anti-Assignment Clause and the Loan Agreement manifests both a clear intention to forbid the assignment of the Promissory Note itself, and any rights thereunder.”

While not breaking new ground, the case reinforces the court’s view that “claim purchasers are sophisticated entities that are capable of both assessing the risk of disallowance through due diligence, and mitigating that risk through contractual provisions, such as indemnities.” It also serves as a reminder that reviewing the underlying documents for transfer restrictions is a critical part of a claim purchaser’s due diligence. While not clear from the decision whether settling the transfer via participation would have overcome the disability, it is good practice to include a “participation savings clause” that takes effect if an assignment is deemed invalid. Finally, what is also not clear is whether the result would have been different if the seller had filed a proof of claim before or in conjunction with the transfer.