BANKRUPTCY AND THE AUTO INDUSTRY: AN ANALYSIS OF (1) THE EFFECTS OF - - PDF document

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BANKRUPTCY AND THE AUTO INDUSTRY: AN ANALYSIS OF (1) THE EFFECTS OF THE RECENT CHANGES TO THE BANKRUPTCY CODE ON AUTO INDUSTRY BANKRUPTCIES; (2) COURT OPINIONS IN AUTO INDUSTRY BANKRUPTCIES; AND (3) SPLITS AMONG THE CIRCUITS WHERE AUTO INDUSTRY BANKRUPTCIES ARE MOST OFTEN FILED

Prepared for the Turnaround Management Association Pittsburgh Chapter Presented February 21, 2006 By: David A. Murdoch Jamie A. Bishop Jamie L. Burchianti Lopez Kirkpatrick & Lockhart Nicholson Graham LLP Henry W. Oliver Building 535 Smithfield Street Pittsburgh, PA 15222 (412) 355-6500

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I. Changes to the Bankruptcy Code That Affect Business Bankruptcies A. Time Limitations on a Debtor s Ability to Submit a Plan for Reorganization 1. Old Law: a. Previously, debtors had an exclusive right to file a plan of reorganization during the first 120 days after the commencement

• f the case. 11 U.S.C. § 1121(b) (2000).

b. In practice, courts have been very lenient in granting numerous extensions to debtors. 2. Changes in the Code: a. Section 1121 of the Bankruptcy Code has been amended to reduce the lengthy extensions that have been granted by bankruptcy

• courts. The new law states that the 120-day period may not be

extended beyond 18 months after the petition date. 11 U.S.C. § 1121(d)(2)(A). b. If the debtor s exclusive period to file a plan of reorganization expires, the creditors committee or any other party-in-interest can file its own plan of reorganization or liquidation for the debtor. c. Creditors have gained leverage because of this change. Creditors now know that if a debtor cannot submit a plausible plan by the deadline, a creditor can submit its own plan of reorganization. The absolute limitation on a debtor s ability to seek extensions to file its plan allows a creditors committee to refuse to negotiate with the debtor as the deadline approaches. Once the deadline passes, the committee can submit its own reorganization plan for the debtor. B. Capping Executive Compensation 1. Old Law: a. The Bankruptcy Code did not limit executive compensation. b. When larger corporations filed Chapter 11 reorganization cases, senior executives often were enrolled in Key Employee Retention Programs ( KERPS ) or given luxurious monetary incentives to remain with the company. c. In many cases, only senior executives received these payments, usually in the form of a bonus. The bonuses frequently were large and diluted the cash available for distribution to creditors.

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2. Changes in the Code: a. Retention: i. The amended Bankruptcy Code states that retention programs for the purpose of convincing an insider to remain with the debtor s company are not allowed unless the payment is both: (a) essential to retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation; and (b) the services provided by the person are essential to the survival of the business. 11 U.S.C. § 503(c). ii. Even if both requirements are satisfied, the amount that an individual can receive under a retention program is capped. An individual s compensation cannot be 10 times the average amount given to non-management employees for any purpose during the calendar year in which the

• bligation is incurred. 11 U.S.C. § 503(c)(1)(C).

b. Severance: i. Severance payments cannot be made to insiders unless the payments are part of a larger program generally available to all full-time employees. 11 U.S.C. § 503(c)(2). ii. The amount of compensation that an insider can receive in a severance package is limited. An insider s severance package may not be greater than 10 times the average severance pay given to non-management employees in that year. C. Changes Relating to Preference Actions 1. Ordinary Course of Business Defense a. Old Law: i. Previously, to qualify for the ordinary course of business exception to a preference action, a creditor had to prove three elements:

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(a) the transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and creditor; (b) the transfer was made in the ordinary course of business between the debtor and creditor; and (c) the transfer was made in accordance with ordinary business terms. 11 U.S.C. § 547 (c)(2) (2000). ii. Courts struggled in determining what the difference was between the ordinary course of business between the debtor and creditor element and the ordinary business terms element. As a result, courts read this statutory provision as requiring creditors to prove that transactions were subjectively and objectively ordinary. (a) The Subjective Test: (1) The creditor has to prove that the payment was the typical type of payment made in the parties established course of dealings. (2) The creditor must show that transactions both before and during the 90-day period were consistent. (3) Factors to determine if the transfer was

• rdinary are:

i) the length of time the parties were engaged in the transaction in issue; ii) whether the amount or form of tender differed from past practices; iii) whether the debtor or creditor engaged in any unusual collection or payment activities; and iv) the circumstances under which the payment was made.

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Payne v. Clarendon Nat l Ins. Co. (In re Sunset Sales, Inc.), 220 B.R. 1005 (B.A.P. 10th Cir. 1998). (b) The Objective Test: (1) A creditor also was forced to show that the payment was made according to ordinary business terms used in an established industry standard. (2) To prove that the objective prong of the test was satisfied, creditors usually had to hire expert witnesses to testify at trial. Therefore, even if a creditor could prove that a payment was made in the ordinary course

• f business, it typically had to spend large

amounts of money on expert witnesses and litigation. b. Changes in the Code: i. Elements of the New Defense: (a) The transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and creditor; and either (1) the transfer was made in the ordinary course

• f business or financial affairs of the debtor

and the creditor; or (2) the transfer was made according to ordinary business terms. 11 U.S.C. § 547 (c)(2). ii. Realizing the tremendous expense and difficulty for a creditor to prove that a transaction was made in ordinary business terms used in a particular business and locality, Congress altered the ordinary course of business defense in a way that eliminates the need for objective data in most cases.

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2. Small Transfer Exception: a. Creditors who received payments during the 90-day period prior to the filing of the debtor s petition are no longer required to return the payments if the amount received is less than $5,000. b. The small transfer exception is an affirmative defense that must be raised by the creditor. 11 U.S.C. § 547(c)(9). 3. Venue Amendments a. If a preference action against a business creditor who is not an insider is for less than $10,000, the preference action must be brought in the creditor s home district, regardless of where the bankruptcy petition was filed. 28 U.S.C. § 1409(b). b. Creditors who are forced to defend preference actions for claims less than $10,000 no longer have to hire counsel in the jurisdiction where the case was originally filed. D. Reclamation Demands 1. Old Law a. Under old law, it was clear that § 546(c) attempted to protect a seller s rights to reclamation under section 2-207 of the Uniform Commercial Code. b. The seller could only reclaim goods if the seller demanded reclamation of such goods in writing before 10 days after receipt

• f such goods by the debtor or if the 10 days expired after

commencement of the case, before 20 days after receipt of such goods by the debtor. c. The court could deny reclamation to a seller that made a demand if the court granted the claim administrative priority or secured the claim by a lien. 2. Changes in the Code a. Because of the lengthening of the reclamation period under the changes to the Bankruptcy Code and the elimination of language regarding statutory and common law rights in § 546(c), it appears that the statute creates a federal right of reclamation in bankruptcy cases. b. Seller may only reclaim goods if the seller demands reclamation of such goods in writing no later than 45 days after the date the

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debtor received the goods or not later than 20 days after the date of commencement of the case, if the 45-day period expires after the commencement of the case. c. If a seller fails to provide written notice of reclamation demand within the time required, the seller still holds an administrative expense claim equal to the value of any goods sold to the debtor in the ordinary course of the debtor s business within 20 days before the petition date. E. Timing Changes for Non-Residential Real Property Leases 1. Old Law: a. Previously, debtors had 60 days to decide whether to assume or reject a commercial real property lease. Debtors were allowed to seek continual and unlimited time extensions by showing cause. Landlords did not have an ability to force a debtor to decide whether to assume or reject the lease. 11 U.S.C. § 365 (d)(4) (2000). b. Commercial landlords did not have leverage when dealing with lessees who filed for bankruptcy. 2. Changes in the Code: a. The debtor now has 120 days after the filing of the petition to assume or reject a commercial real property lease. The court still can grant an extension by the showing of cause, but the extension can be no longer than 90 days (210 days after the filing of the petition). 11 U.S.C. § 365 (d)(4)(B)(i). b. If the debtor needs additional extensions, it must obtain the written permission of the landlord. 11 U.S.C. § 365 (d)(4)(B)(ii). c. This new power to grant or deny additional time extensions gives commercial landlords the ability to negotiate with the debtor directly to obtain more favorable terms under the existing lease. II. Abstracts of Opinions in Auto Industry Bankruptcies A. Treatment of Claims 1. In re Acoustiseal, Inc., 290 B.R. 354 (Bankr. W.D. Mo. 2003). Various former employees of Debtor moved for the allowance of severance pay and benefits to be treated as administrative expenses of the estate under 11 U.S.C. §503(b). The employees were all terminated post-petition except for one employee who was forced to resign pre-petition.

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The terminated employees argued that their severance benefits constituted wages or salary to be paid as an administrative expense under §503(b)(1)(A). The executive employees whose retention agreements gave them a right to severance benefits acquired their rights to such benefits immediately upon executing the retention agreements, which was pre-petition. Therefore, the Court found that those claims were not entitled to administrative expense priority, and were unsecured claims. The Court held that the claims for severance that accrued post- petition were to be treated as administrative expenses because the severance benefits were compensation for services and the post-petition services were a benefit to the estate. To the extent the claims accrued within 90 days prior to the Debtor filing its petition and were allowable under 11 U.S.C. §507(a)(3)(A), they were to be treated as priority, unsecured, pre-petition claims. 2. In re FV Steel & Wire Co., 310 B.R. 390 (Bankr. E.D. Wis. 2004). A creditor filed a UCC financing statement under a trade name rather than the legal name of

• Debtor. A heavy burden is placed on creditors who file erroneous financing statements. The

Court took into consideration the underlying purpose of the UCC s filing requirements as well as the publicity that was surrounding the impending adoption of a revised UCC Article 9 that stresses the importance of using the correct legal name. The Court held that filing under the trade name was seriously misleading and ineffective to perfect a security interest. 3. In re Dynamic Tours & Transp., Inc., No. 6:04-BK-02009-6B1, 2004 WL 3217636 (Bankr. M.D. Fla. Nov. 19, 2004). Debtor and Lessor entered into lease agreements for buses. The Court held that the lease agreements between Debtor and Lessor were leases and not financing agreements because Debtor could terminate the agreements early without incurring an obligation to Lessor for the total cost of the buses. 4. U.S. Aeroteam, Inc. v. Delphi Auto. Servs. (In re U.S. Aeroteam, Inc.),

• No. 04-3047, 2005 Bankr. LEXIS 1900 (Bankr. S.D. Ohio August 1,

2005). Aeroteam was a manufacturer of parts, including automobile parts, and Delphi, a Tier 1 manufacturer and supplier was one of its largest customers. The contract between Aeroteam and Delphi included a provision for setoff and applicable state law provided for setoff. After Aeroteam filed for bankruptcy, Delphi filed a motion for relief from stay to exercise an alleged right to offset amounts Aeroteam owed to Delphi for Aeroteam s purchase of products from certain divisions of Delphi and Delphi s payment of Aeroteam s debt to Aeroteam s supplier essential to the continued production of goods by Aeroteam for Delphi against amounts Delphi

• wed to Aeroteam. The Court held that Delphi had a valid right to offset its debt to Aeroteam

against Aeroteam s debt to Delphi for both the products purchased by Aeroteam from Delphi and for the third party supplier claim that had been assigned to Delphi. However, Delphi accrued much of its debt to Aeroteam during the 90 days prior the filing of the bankruptcy. Therefore, the Court held that the amount of debt Delphi could offset should be determined by whether Aeroteam was insolvent when the debt was accrued. The Court further stated that there was an

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issue of material fact as to whether Aeroteam was solvent. Therefore, the matter needed to proceed to trial. B. The Automatic Stay 1. In re FV Steel & Wire Co., 324 B.R. 701 (Bankr. E.D. Wis. 2005). The EPA argued that Debtor s obligation under an EPA Consent Decree to monitor and maintain a groundwater treatment system was not stayed by § 362 of the Bankruptcy Code because it fell within the police and regulatory exception. The stay exception includes the enforcement of a judgment, other than a money judgment. Debtor never owned or operated the facilities in question and was not being enjoined from anything. The actual cleanup had been completed. The Debtor argued that based on those circumstances the only means of satisfying the terms of the Consent Decree would be through the payment of money which in effect would be the enforcement of a money judgment. Because Congress clearly intended actions to collect money judgments arising from police and regulatory actions to be subject to the automatic stay, the Court found that the EPA was not entitled to relief from the automatic stay. C. Sale of Assets 1. In re Standard Auto. Corp., No. M-47, 2002 WL 31007423 (S.D.N.Y. Sept. 6, 2002). Before the Government sought a stay pending appeal, Debtor sold certain assets pursuant to a bankruptcy court order. Four factors were cited in considering whether to stay the action, including: (1) whether the movant will suffer irreparable injury absent a stay; (2) whether a party will suffer substantial injury if a stay is issued; (3) whether the movant has demonstrated a substantial possibility, although less than a likelihood, of success on appeal; and (4) what public interests may be affected. The Court held that the Government s appeal was moot under §363 (m) of the Bankruptcy Code, which provides that the reversal or modification on appeal of an authorization of a debtor s sale or lease of property does not affect the validity of such sale or lease to an entity that purchased or leased the property in good faith. The Court further held that it would go against the policy of §363 to set aside a transaction entered into in good faith. 2. In re Webster Classic Auctions, Inc., 318 B.R. 216 (Bankr. M.D. Fla. 2004). Debtor brought a motion for an order requiring the reimbursement of documentary stamps under 11 U.S.C. §1146(c), which exempts transfers under a plan confirmed from stamp taxes. Debtor sold property pursuant to an Order Granting Motion to Approve Sale of Property Free and Clear of Liens. There was no mention of §1146(c) in the Motion or the Order. There were no findings regarding the necessity of the sale for reorganization. At the time of the sale, there was no plan of reorganization or disclosure statement filed. The Court adopted the following criteria for determining if §1146(c) is applicable: (1) there must be a plan of reorganization specifically contemplating a sale of property and the plan must ultimately be confirmed; (2) any sale of property contemplated in the plan which is sought to be sold prior to confirmation must set out the requirements of §1146(c) and must be served on all relevant taxing authorities; (3) the

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notice to taxing authorities must be included in the required §363(b) sale motion; and (4) the Court must determine whether the sale meets all the other requirements found in §363 and §1146(c). The Court denied the Motion holding that the sale of real property by Debtor was not under a plan confirmed because the Debtor had no plan of reorganization at the date of the transfer. D. Preference Proceedings 1. HLI Creditor Trust v. Keller Rigging Constr., Inc. (In re Hayes Lemmerz Int l Inc.), 312 B.R. 44 (Bankr. D. Del. 2004). Defendant in a preference proceeding moved for change of venue. A proceeding may be transferred in the interest of justice or for the convenience of the parties. A defendant has the burden of demonstrating by a preponderance of the evidence that a transfer of venue is

• warranted. The Court looked at twelve different factors in determining whether to transfer
• venue. In reviewing the factors, the Court gave deference to the Plaintiff s choice of forum and

found that neither the situs of the underlying contract or the situs of performance of the contract was at issue in the preference action, that the location of the books and records were not of great concern, that witnesses would only be minimally inconvenienced in coming to Delaware, that a transfer would increase expenses, and that if this case were transferred, it would open the door for other preference defendants to transfer their cases resulting in the imposition of unnecessary costs on the Plaintiff. The Court would not transfer venue because of the strong presumption in favor of keeping venue where a bankruptcy case is pending. The Defendant failed to rebut this presumption. 2. HLI Creditor Trust v. Hyundai Motor Co. (In re Hayes Lemmerz Int l, Inc.), 329 B.R. 136 (Bankr. D. Del. 2005). The Creditor Trust brought an action to void payment to a manufacturer as a preferential transfer. Debtors ordered machines from Defendants with a 20% payment due on delivery and other installment payments. The Debtors sent the payment via mail within three days of receiving the documents required to take possession of the machines, but the check did not arrive until after they had possession. The Creditor Trust asserted that the transfer was a voidable preference under §547(b)(2) because it was an antecedent debt and involved property of the Debtors. The Court held that the payment was an antecedent debt because the Debtors were legally obligated to pay the purchase price the day they signed the purchase order. However, the Court held that there was a genuine issue of material fact as to whether the transfer involved an interest of the Debtors. The Defendant moved for summary judgment on the ground that the transfer was exempt from avoidance under §547(c)(1) because it was intended to be contemporaneous and was a substantially contemporaneous exchange. The Creditor Trust argued that it was a credit transaction and therefore not exempt. The Court found that the parties intended the exchange to be contemporaneous but that the Court did not have enough evidence on whether it was substantially contemporaneous to grant summary judgment on the contemporaneous exchange of value defense.

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3. Strauss v. Janesville Prods. (In re Acoustiseal, Inc.), 318 B.R. 521 (Bankr. W.D. Mo. 2004). The Chapter 7 Trustee sought to avoid alleged preferential payments to Debtor s Supplier under §547(b). The Supplier asserted ordinary course of business and subsequent new value defenses. The parties filed cross-petitions for summary judgment. The Debtor and Supplier had a business relationship and the Debtor consistently paid for merchandise somewhat late prior to the preference period. The Supplier provided new product to the Debtor during the preference

• period. The Court held that there was a genuine issue of material fact as to whether the particular

late payments from Debtor to Supplier during the 90-day preference period were in the ordinary course of business. The Court further held that the new value Supplier provided to Debtor could be applied against all, not just the immediately preceding, preferential payments to reduce or eliminate the amount of the preference claims. E. Critical Vendor Defense 1. Zenith Indus. Corp. v. Longwood Elastomers, Inc. (In re Zenith

• Indus. Corp.), 319 B.R. 810 (Bankr. D. Del. 2005).

Debtor filed a complaint against Supplier to recover alleged preferential transfers. The Court entered an Essential Vendor Order authorizing, but not requiring, Debtor, in its sole discretion, to pay pre-petition claims of certain essential vendors in an amount not to exceed $1,000,000. The Bankruptcy Court granted Debtor s motion to strike the essential vendor defense asserted by

• Supplier. Supplier moved for reconsideration. The Court found Supplier s argument that if it

had not received the preferential transfer pre-petition, it would have been paid under the Essential Vendor Order to be speculative. The facts that the Essential Vendor Order did not require that any payments be made, that the payments were made before the Essential Vendor Order was entered, and that the payment in question was $506,035 when the critical vendor cap was $1,000,000 also went against an essential vendor defense. The court held that the essential vendor defense was legally insufficient. 2. HLI Creditor Trust v. Export Corp. (In re Hayes Lemmerz Int l Inc.), 313 B.R. 189 (Bankr. D. Del. 2004). Creditor Trust brought action to recover alleged preferential transfers from a warehouseman that stored Debtors products and delivered them just-in-time to customers. The Court ordered that Debtors could pay certain pre-petition shipping and warehouse charges in order to assure continued services by critical vendors (the Critical Vendor Order ). The transfers in question were all received before the Critical Vendor Order was entered. The Court denied the Defendant s motion to dismiss on the grounds that Plaintiff could potentially prove that the pre- petition transfers at issue are greater than what Defendant would have received under Chapter 7 liquidation pursuant to §547(b)(5). The Court further held that the payments were not protected under the Critical Vendor Order because they were made before the Motion was filed and the Critical Vendor Order was entered. Additionally, because the Critical Vendor Order is permissive, not mandatory, the warehouseman was not entitled to receive payment of all pre- petition claims.

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F. Creditors Committee Fees 1. In re Veltri Metal Prods., Inc., No. 04-40993-R, 2004 Bankr. LEXIS 2400 (Bankr. E.D. Mich. Dec. 16, 2004). Counsel for creditors committee filed an application for allowance of fees and expenses. The Court held that the services were not reasonably likely to benefit the Debtor s estate because there has been and will be no distribution to the unsecured creditors, nor does it appear that there ever was a reasonable likelihood of a distribution. The Court cited a potential exception to this rule for preferences and fraudulent conveyance recoveries collected by the Chapter 7

• Trustee. Counsel in this case arranged for an investigation into such recoveries, but the Court

could not discern to what extent counsel s services were in relation to preferences and fraudulent

• conveyances. The Court denied the application without prejudice to applicant s right to file an

application for fees that identify the services rendered in investigating preferences and fraudulent conveyances. 2. In re Veltri Metal Prods., Inc., No. 04-40993-R , 2005 Bankr. LEXIS 1969 (Bankr. E.D. Mich. Jan. 26, 2005). The Court revisited the above case as to whether counsel to a creditors committee was entitled to an allowance of fees and expenses. The Court denied counsel s motion for reconsideration because counsel s services were not necessary to the administration of the estate or reasonably likely to benefit the estate, and the applicant did not specifically identify the services and hours relating to preferences and fraudulent conveyances. G. Freedom of Contract 1. In re Venture Holdings Co., No. 03-48939, 2005 Bankr. LEXIS 76(Bankr. E.D. Mich. Jan. 26, 2005). Eleven Debtors were seeking confirmation of Debtors Joint Plan of Reorganization (the Plan ). Winget, the beneficial owner of the Debtors and various other entities, and others filed objections to confirmation. The court denied confirmation. The Contribution Agreement, whereby Winget and entities controlled by him were to contribute assets to the reorganized Debtors, required Debtors to meet certain requirements, including the execution and delivery of a commitment letter for exit financing in an amount of $85 million (or such other amount mutually agreed upon by Venture Holdings, Winget, and the Agent) no later than the date of the hearing on the Disclosure Statement, and otherwise on terms acceptable to

• Winget. If this condition was not met, Winget had the right to terminate the Contribution
• Agreement. The Contribution Agreement was the basis of the Plan and was essential for

confirmation of the Plan. On the date of the Disclosure Statement hearing, a commitment letter for exit financing was delivered in the amount of $125 million and included numerous terms and

• conditions. Winget wrote a letter the same day terminating the Contribution Agreement saying it

did not meet the requirements set forth in the Contribution Agreement. Because the exit financing was not otherwise on terms acceptable to Winget as required under the Contribution Agreement, Winget had the right to terminate the Contribution Agreement and did

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• so. Plan proponents argued that because there was a best efforts requirement in the

Contribution Agreement, Winget could not refuse exit financing in an amount over $85 million. The Court rejected this argument as being against the plain meaning of the contract. The Court held that Winget validly terminated the Contribution Agreement. Therefore, the confirmation of the Plan had to be denied. The Court also held that Winget did not breach the implied covenant

• f good faith and fair dealing because some of the terms in the exit financing agreement were

excessive and unreasonable. The provision giving Winget discretion to terminate did not render the contract illusory because it was negotiated by all parties and was limited by the implied covenant of good faith and fair dealing. 2. In re FV Steel & Wire Co., 331 B.R. 385 (Bankr. E.D. Wis. 2005). The EPA named CRI Steering Committee and the Glidden Company (collectively, the Claimants ) as well as FV Steel, as potentially responsible parties with respect to a site needing environmental clean-up (the Site ). Prior to filing its petition for bankruptcy, FV Steel was party to a Participation Agreement whereby it shared clean-up costs and remediation expenses related to the Site. Pursuant to the terms of the Participation Agreement, Debtor withdrew from the Participation Agreement. Under the Participation Agreement, a withdrawing party was only liable for its share of allocated costs assessed thirty days or more prior to withdrawal. After Debtor withdrew, the EPA required additional work to be done at the Site. Claimants filed proofs of claim against Debtor for environmental clean-up costs. When Debtor withdrew, it was not liable for any costs. The Court held that Debtor did not have to contribute additional funds because its withdrawal was valid. Therefore, the Claimants did not have a valid claim. The Court implied that the Claimants may be able to amend their proof of claim to assert claims on behalf of the EPA under §501(b) of the Bankruptcy Code. Although the bar date had expired, the Court did not foreclose the possibility of filing a motion to allow a late-filed claim under the excusable neglect standard. H. Tax Issues 1. In re Harvard Indus., Inc., 324 B.R. 238 (Bankr. D.N.J. 2005). Harvard Industries filed a tax refund motion seeking refund of payments that they alleged were specified liability losses. The payments were: (1) amounts Harvard Industries expended to settle products liability claims related to products that were to be sold to distributors and intended for resale and (2) amounts Harvard Industries contributed to its pension plans. The Bankruptcy Court held that amounts paid to settle the products liability claims were specified liability losses that could be carried back pursuant to 26 U.S.C. §172(f) because they were liabilities due to the loss of use of the defective products. The Bankruptcy Court also held that the contributions to pension plans were specified liability losses because the payments were on liabilities arising under the federal law, ERISA, and were not based on voluntary business choices.

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2. IRS v. Harvard Secured Creditors Liquidation Trust, No. 05-1968, 2005 WL 2397224 (D.N.J. Sept. 28, 2005). The District Court reversed the Bankruptcy Court s decision summarized above. The District Court held that the payments to settle claims were not damages as a result of loss of the use of property within the definition of product liability under 26 U.S.C. § 172 because the use, that of being suitable for resale, was never in existence. Thus, payments were not a specified liability loss under §172. The amounts contributed to the pension plans were not liabilities that arose under federal or state law, meaning the nature and amount of the liability was not traceable to a specific law and could be the result of choices made by the taxpayer and others. Thus, the amounts contributed to pension plans were not specified liability losses. III. Circuit Splits involving the Second, Third, and Sixth Circuits A. What is the Current Status of the Critical Vendor Defense? 1. Background While there is no explicit provision of the Bankruptcy Code that permits critical vendor payments, prior to the Seventh Circuit's decision in In re Kmart Corp., 359 F.3d 866 (7th Cir. 2004), many bankruptcy courts used their equitable powers under the doctrine of necessity to allow the debtor to designate some vendors as necessary to the debtor's reorganization. The doctrine of necessity is derived from §105 of the Bankruptcy Code and is a general equitable provision that applies to all bankruptcies. In evaluating the Kmart case, the Seventh Circuit declared that the doctrine of necessity can no longer serve as the basis for a critical vendor order. However, the Court did state that §363(b) might justify critical vendor orders in very limited circumstances. 2. Second Circuit It appears that creditors can still obtain critical vendor status in the Second Circuit. On December 12, 2005, the Bankruptcy Court for the Southern District of New York granted Delphi Corporation s critical vendor motion under 11 U.S.C. §§ 363(b) and 365(a) to pay the pre- petition claims of sole source suppliers who provide Delphi with goods that are critical to its manufacturing operations. In re Delphi Corp., No. 05-44481 (RDD) (Bankr. S.D.N.Y., Dec. 12, 2005) (Order To Assume Certain Amended and Restated Sole Source Supplier Agreements). In 2002, the same court allowed Worldcom to pay up to $70 million of its pre-petition debts to critical vendors that agreed to supply goods and services to it on customary trade terms during the pendency of the bankruptcy case. In re Worldcom, Inc., No. 02-13533(AJG), 2002 WL 1732647 (Bankr. S.D.N.Y., July 22, 2002) (Order Pursuant to Section 105(a) of the Bankruptcy Code Authorizing Payment of Pre-petition Claims of Critical Vendors). In Worldcom, however, the Bankruptcy Court based its order completely on the doctrine of necessity under § 105(a) to allow the critical vendor payments. It should be noted that in In re Delphi, the court rested its

• rder on § 363(b) of the Bankruptcy Code

the same section that the Seventh Circuit stated might be a basis for critical vendor payments in the Kmart decision. While no court in the Second Circuit has expressly stated the standard by which critical vendor motions will be judged, it appears that the court is following the Seventh Circuit s lead in Kmart.

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3. Third Circuit The status of critical vendors has not been litigated in the Third Circuit since Kmart was decided. Though a bankruptcy judge deciding whether or not he or she should grant a critical vendor motion would probably consider Judge Easterbrook s opinion in Kmart, bankruptcy court precedent currently permits pre-petition payments to a critical vendor by virtue of the necessity

• f payment doctrine under § 105(a). In re Just for Feet, Inc., 242 B.R. 821, 825 (Bankr. D. Del.

1999). In its decision to grant the debtor s critical vendor motion in In re Just for Feet, the court explicitly rejected the creditors argument that § 105(a) did not permit the court to issue a critical vendor order that authorizes pre-petition claims. Indeed, according to the bankruptcy court, the

• nly issue that the court must decide in determining if it should exercise its equitable powers and

grant the debtor s motion is whether the debtor has met its burden and demonstrated that payment of the pre-petition claims is critical to the debtor s reorganization. While the Third Circuit likely will re-evaluate critical vendor designations in light of Kmart, there have been no recent decisions from the Third Circuit that discuss a more restrictive approach to critical vendor

• rders.

4. Sixth Circuit No courts in the Sixth Circuit have discussed the continued validity of critical vendor orders since Kmart. Furthermore, no courts in the Sixth Circuit have ever discussed the standard by which critical vendor motions are evaluated. While there is no explicit discussion of the standard by which critical vendor evaluations are decided, case law suggests that critical vendor orders are available in the Sixth Circuit only in very extraordinary circumstances. In re Chandlier, 292 B.R. 583, 588 (W.D. Mich. 2003). One district court in the Sixth Circuit has suggested that to qualify as a critical vendor, the creditor must furnish unique goods or services to the debtor that cannot be obtained elsewhere. While it is possible to obtain a critical vendor order in the Sixth Circuit, it appears that critical vendor orders will not be granted frequently. B. Can Paid New Value be an Affirmative Defense to a Preference Action? 1. Third Circuit The Third Circuit has held that the subsequent new value must remain unpaid to be a successful affirmative defense. The court further held that the creditor can set-off unpaid new value against preferential transfer amounts that must be returned to the trustee. N. Y. City Shoes, Inc. v. Bentley Int l, Inc. (In re N. Y. City Shoes, Inc.), 880 F.2d 679 (3d Cir. 1989). 2. Bankruptcy Court of the Southern District of Ohio A bankruptcy court in the Sixth Circuit held that subsequent new value does not need to remain unpaid for a creditor to assert a successful affirmative defense based on new value. The court held that the repaid amount of subsequent new value can reduce any prior preference payments. In re Roberds, Inc., 315 B.R. 443 (Bankr. S.D. Ohio 2004).

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C. Is an Appeal Automatically Mooted Without a Stay of the Impending Sale and Transfer under §363(m)? 1. Second Circuit The Second Circuit has held that the appeal is moot absent a stay of the sale under §363(m). In United States v. Salerno, 932 F.2d 117 (2d Cir. 1991), the court held that § 363 precludes appeal because the sale was consummated prior to any appeal. 2. Third Circuit The Third Circuit rejected a per se rule of mootness. Instead the Court formulated two prerequisites for mootness: (1) the underlying sale was not stayed pending appeal, and (2) the court must determine whether reversing or modifying the authorization to sell or lease would affect the validity of the sale or lease by looking at the remedies requested by appellants. Krebs Chrysler-Plymouth, Inc. v. Valley Motors, Inc., 141 F.3d 490 (3d Cir. 1998). 3. Sixth Circuit The Sixth Circuit held that §363(m) precluded an appeal of the bankruptcy court s approval of a plan for liquidation. The court found that the liquidation plan which involved selling the single asset of the debtor was essentially a sale. Because the parties did not obtain a stay prior to the sale, appeal was precluded. In re 255 Park Plaza Assoc., LP, 100 F.3d 1214 (6th Cir. 1996). D. Must Courts Rule on Requested Time Extensions within 60 Days under §365(d)(4)? 1. Background The former §365(d)(4) provided that a trustee had to assume or reject an unexpired lease of non- residential real property within 60 days after the date of the order for relief, or within the additional time as the court, within the 60-day period, fixes, or the lease is deemed rejected. The amended §365(d)(4) gives the trustee 120 days from the order for relief or the date of the entry of an order confirming the plan to assume or reject the lease before the lease is deemed

• rejected. The court may extend the period, prior to the expiration of the 120-day period, for 90

days, and may grant a subsequent extension if the lessor gives prior written consent. 2. Third Circuit The Third Circuit has held that the court does not need to rule on the requested extensions within the 60-day period under §365(d)(4). It found that such a result would be at odds with the intentions of the drafters of the statute. In re Channel Home Ctrs., Inc., 989 F.2d 682 (3d Cir. 1993).

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3. Bankruptcy Court for the Eastern District of New York A bankruptcy court in the Second Circuit held that the request and decision for an extension must be within the 60-day period. In re House of Deals, Inc., 67 B.R. 23 (Bankr. E.D.N.Y. 1986). 4. Bankruptcy Court for the Western District of Michigan A bankruptcy court in the Sixth Circuit held that so long as the motion is filed prior to the expiration of the 60-day period, the court can grant an extension even if it is outside the 60-day

• period. In re Travel 2000, Inc., 264 B.R. 451 (Bankr. W.D. Mich. 2001).

5. Bankruptcy Court for the Eastern District of Michigan Another bankruptcy court in the Sixth Circuit came to a different conclusion from the preceding

• cases. It looked to the plain language of the statute and determined that extensions could not be

granted when consideration of the motion for extension occurred outside the 60-day period. In re DCT, Inc., 283 B.R. 442 (Bankr. E.D. Mich. 2002). E. When Does a Claim Arise for Bankruptcy Discharge Purposes When the Claim is Unmatured on the Petition Date? 1. Second Circuit In the Second Circuit, if the creditor and debtor began a relationship pre-petition and the underlying act occurred before bankruptcy, the claim is discharged. In re Chateaugay Corp., 944 F.2d 997 (2d Cir. 1991). This approach has been criticized for being unfair to creditors who have claims discharged even though they do not know that the claim exists. 2. Third Circuit Under the Third Circuit s approach, all the elements of a claim have to exist prior to bankruptcy for the claim to be dischargeable. For example, in an environmental context, the claim does not arise until response costs have been incurred. In re M. Frenville Co., 744 F.2d 332 (3d Cir. 1984). This approach looks to the underlying, non-bankruptcy law to determine when a claim arises. F. Is the Transfer Tax Exemption Limited to Transfers of Property by a Debtor after Confirmation of a Plan? 1. Second Circuit The Second Circuit has not explicitly addressed the issue but has read §1146(c) of the applicable statute very broadly. This implies that it would possibly apply the transfer tax exemption to transactions that take place pre-confirmation. City of N.Y. v. Jacoby-Bender, Inc. (In re Jacoby- Bender, Inc.), 758 F.2d 840 (2d Cir. 1985). The Second Circuit in Jacoby-Bender held that a post-confirmation sale that was not specifically described or required by the plan fell under the §1146(c) exemption. It also held that any sale effectuating the plan is subject to the exemption.

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2. Third Circuit The exemption from a stamp or other transfer tax under §1146(c) is not applicable to a sale of property that takes place pre-confirmation. Baltimore County, Md. v. Hechinger Liquidation Trust (In re Hechinger Inv. Co. of Del., Inc.), 335 F.3d 243 (3d Cir. 2003).

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APPENDIX Text of the Bankruptcy Code Showing Changes made by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 11 U.S.C. § 1121 § 1121. Who may file a plan (a) The debtor may file a plan with a petition commencing a voluntary case, or at any time in a voluntary case or an involuntary case. (b) Except as otherwise provided in this section, only the debtor may file a plan until after 120 days after the date of the order for relief under this chapter. (c) Any party in interest, including the debtor, the trustee, a creditors committee, an equity security holders committee, a creditor, an equity security holder, or any indenture trustee, may file a plan if and only if (1) a trustee has been appointed under this chapter; (2) the debtor has not filed a plan before 120 days after the date of the order for relief under this chapter; or (3) the debtor has not filed a plan that has been accepted, before 180 days after the date of the order for relief under this chapter, by each class of claims or interests that is impaired under the plan. (d) On (1) Subject to paragraph (2), on request of a party in interest made within the respective periods specified in subsections (b) and (c) of this section and after notice and a hearing, the court may for cause reduce or increase the 120-day period or the 180-day period referred to in this section. (e) In a case in which the debtor is a small business and elects to be considered a small business (1)

• nly the debtor may file a plan until after 100 days

(2)(A) The 120-day period specified in paragraph (1) may not be extended beyond a date that is 18 months after the date of the order for relief under this chapter,. (B) The 180-day period specified in paragraph (1) may not be extended beyond a date that is 20 months after the date of the order for relief under this chapter. (e) In a small business case (2) all plans shall be filed within 160 (1) only the debtor may file a plan until after 180 days after the date of the order for relief, unless that period is

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(A) extended as provided by this subsection, after notice and a hearing; or (B) the court, for cause, orders otherwise; (2) the plan and a disclosure statement (if any) shall be filed not later than 300 days after the date of the order for relief; and (3)

• n request of a party in interest made within the respective

the time periods specified in paragraphs (1) and (2) and after notice and a hearing, the court may-, and the time fixed in section 1129(e) within which the plan shall be confirmed, may be extended only if (A) reduce the 100-day period or the 160-day period specified in paragraph (1) or (2) for cause; and (B) increase the 100-day period specified in paragraph (1) if the debtor shows that the need for an increase is caused by circumstances for which the debtor should not be held accountable. (A) the debtor, after providing notice to parties in interest (including the United States trustee), demonstrates by a preponderance of the evidence that it is more likely than not that the court will confirm a plan within a reasonable period of time; (B) a new deadline is imposed at the time the extension is granted; and (C) the order extending time is signed before the existing deadline has expired. 11 U.S.C. § 503 § 503. Allowance of Administrative Expenses (c) Notwithstanding subsection (b), there shall neither be allowed, nor paid (1) a transfer made to, or an obligation incurred for the benefit of, an insider of the debtor for the purpose of inducing such person to remain with the debtor s business, absent a finding by the court based on evidence in the record that (A) the transfer or obligation is essential to retention of the person because the individual has a bona fide job offer from another business at the same

• r greater rate of compensation;

(B) the services provided by the person are essential to the survival of the business; and

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(C) either (i) the amount of the transfer made to, or obligation incurred for the benefit of, the person is not greater than an amount equal to 10 times the amount of the mean transfer or obligation of a similar kind given to non-management employees for any purpose during the calendar year in which the transfer is made or the obligation is incurred; or (ii) if no such similar transfers were made to, or obligations were incurred for the benefit of, such non-management employees during such calendar year, the amount of the transfer or obligation is not greater than an amount equal to 25 percent of the amount of any similar transfer

• r obligation made to or incurred for the benefit of such insider for any

purpose during the calendar year before the year in which such transfer is made or obligation is incurred; (2) a severance payment to an insider of the debtor, unless (A) the payment is part of a program that is generally applicable to all full-time employees; and (B) the amount of the payment is not greater than 10 times the amount

• f the mean severance pay given to nonmanagement employees during the

calendar year in which the payment is made; or (3)

• ther transfers or obligations that are outside the ordinary course of

business and not justified by the facts and circumstances of the case, including transfers made to, or obligations incurred for the benefit of, officers, managers, or consultants hired after the date of the filing of the petition. 11 U.S.C. § 547 § 547. Preferences (c) The trustee may not avoid under this section a transfer (1) to the extent that such transfer was (A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and (B) in fact a substantially contemporaneous exchange; (2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was

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(A) in payment of a debt incurred by the debtor made in the

• rdinary course of business or financial affairs of the debtor and the

transferee; or (B) made in the ordinary course of business or financial affairs

• f the debtor and the transferee; and (C) made according to ordinary

business terms; (3) that creates a security interest in property acquired by the debtor (A) to the extent such security interest secures new value that was (i) given at or after the signing of a security agreement that contains a description of such property as collateral; (ii) given by or on behalf of the secured party under such agreement; (iii) given to enable the debtor to acquire such property; and (iv) in fact used by the debtor to acquire such property; and (B) that is perfected on or before 20 30 days after the debtor receives possession of such property; (4) to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor (A) not secured by an otherwise unavoidable security interest; and (B)

• n account of which new value the debtor did not make an
• therwise unavoidable transfer to or for the benefit of such creditor;

(5) that creates a perfected security interest in inventory or a receivable or the proceeds of either, except to the extent that the aggregate of all such transfers to the transferee caused a reduction, as of the date of the filing of the petition and to the prejudice of other creditors holding unsecured claims, of any amount by which the debt secured by such security interest exceeded the value of all security interests for such debt on the later of (A)(i) with respect to a transfer to which subsection (b)(4)(A) of this section applies, 90 days before the date of the filing of the petition; or

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(ii) with respect to a transfer to which subsection (b)(4)(B) of this section applies, one year before the date of the filing of the petition; or (B) the date on which new value was first given under the security agreement creating such security interest; (6) that is the fixing of a statutory lien that is not avoidable under section 545 of this title; (7) to the extent such transfer was a bona fide payment of a debt to a spouse, former spouse, or child of the debtor, for alimony to, maintenance for, or support of such spouse or child, in connection with a separation agreement, divorce decree or other order of a court of record, determination made in accordance with State or territorial law by a governmental unit, or property settlement agreement, but not to the extent that such debt for a domestic support

• bligation;

(A) is assigned to another entity, voluntarily, by operation of law, or

• therwise; or

(B) includes a liability designated as alimony, maintenance, or support, unless such liability is actually in the nature of alimony, maintenance or support;

• r

(8) if, in a case filed by an individual debtor whose debts are primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $600.; or (9) if, in a case filed by a debtor whose debts are not primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $5,000. 28 11 U.S.C. § 1409 § 1409. Venue of Proceeding Arising Under Title 11 or Arising in or Related to Cases Under Title 11 (b) Except as provided in subsection (b) of this section, a trustee in a case under title 11 may commence a proceeding arising in or related to such case to recover a money judgment of or property worth less than $1,000 or a consumer debt of less than $5,000 15,000, or a debt (excluding a consumer debt) against a noninsider of less than $10,000, only in the district court for the district in which the defendant resides.

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11 U.S.C. § 546 § 546. Limitations in Avoiding Powers (c)(1) Except as provided in subsection (d) of this section and in section 507(c), and subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof, the rights and powers of a the trustee under sections 544(a), 545, 547, and 549 of this title are subject to any statutory or common-law the right of a seller of goods that has sold goods to the debtor, in the ordinary course of such seller s business, to reclaim such goods if the debtor has received such goods while insolvent, within 45 days before the date of the commencement of a case under this title, but (1) such a seller may not reclaim any such goods unless such seller demands in writing reclamation

• f such goods

(A) before 10 not later than 45 days after the date of receipt of such goods by the debtor; or (B) if such 10 not later than 20 days after the date of commencement

• f the case, if the 45-day period expires after the commencement of the case,

before 20 days after receipt of such goods by the debtor; and. (2) the court may deny reclamation to If a seller with such a right of reclamation that has made such a demand only if the court -- (A) grants the claim of such a seller priority as a claim of a kind specified

• f goods fails to provide notice in the

manner described in paragraph (1), the seller still may assert the rights contained in section 503(b)(9)1 of this title; or (B) secures such claim by a lien. 11 U.S.C. § 365(d) § 365. Executory Contracts and Unexpired Leases (d)(1) In a case under chapter 7 of this title, if the trustee does not assume or reject an executory contract or unexpired lease of residential real property or of personal property of the debtor within 60 days after the order for relief, or within such additional time as the court, for cause, within such 60-day period, fixes, then such contract or lease is deemed rejected. (2) In a case under chapter 9, 11, 12, or 13 of this title, the trustee may assume

• r reject an executory contract or unexpired lease of residential real property or of

personal property of the debtor at any time before the confirmation of a plan but the court,

• n the request of any party to such contract or lease, may order the trustee to determine

within a specified period of time whether to assume or reject such contract or lease.

1

§ 503(b)(9) states: After notice and a hearing, there shall be allowed administrative expenses, other than claims allowed under section 502(f) of this title, including the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor s business.

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(3) The trustee shall timely perform all the obligations of the debtor, except those specified in section 365(b)(2), arising from and after the order for relief under any unexpired lease of nonresidential real property, until such lease is assumed or rejected, notwithstanding section 503(b)(1) of this title. The court may extend, for cause, the time for performance of any such obligation that arises within 60 days after the date of the

• rder for relief, but the time for performance shall not be extended beyond such 60-day
• period. This subsection shall not be deemed to affect the trustee s obligations under the

provisions of subsection (b) or (f) of this section. Acceptance of any such performance does not constitute waiver or relinquishment of the lessor s rights under such lease or under this title. (4) Notwithstanding paragraphs (1) and (2), in a case under any chapter of this title, if the trustee does not assume or reject (A) Subject to subparagraph (B), an unexpired lease of nonresidential real property under which the debtor is the lessee within 60 days after the date of the order for relief, or within such additional time as the court, for cause, within such 60-day period, fixes, then such lease is shall be deemed rejected, and the trustee shall immediately surrender such that nonresidential real property to the lessor., if the trustee does not assume or reject the unexpired lease by the earlier of (i) the date that is 120 days after the date of the order for relief; or (ii) the date of the entry of an order confirming a plan. (B)(i) The court may extend the period determined under subparagraph (A), prior to the expiration of the 120-day period, for 90 days on the motion of the trustee or lessor for cause. (ii) If the court grants an extension under clause (i), the court may grant a subsequent extension only upon prior written consent of the lessor in each instance. (5) Notwithstanding paragraphs (1) and (4) of this subsection, in a case under any chapter of this title, if the trustee does not assume or reject an unexpired lease of nonresidential real property under which the debtor is an affected air carrier that is the lessee of an aircraft terminal or aircraft gate before the occurrence of a termination event, then (unless the court orders the trustee to assume such unexpired leases within 5 days after the termination event), at the option of the airport operator, such lease is deemed rejected 5 days after the occurrence of a termination event and the trustee shall immediately surrender possession of the premises to the airport operator; except that the lease shall not be deemed to be rejected unless the airport operator first waives the right to damages related to the rejection. In the event that the lease is deemed to be rejected under this paragraph, the airport operator shall provide the affected air carrier adequate

• pportunity after the surrender of the premises to remove the fixtures and equipment

installed by the affected air carrier.

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(6) For the purpose of paragraph (5) of this subsection and paragraph (f)(1) of this section, the occurrence of a termination event means, with respect to a debtor which is an affected air carrier that is the lessee of an aircraft terminal or aircraft gate (A) the entry under section 301 or 302 of this title of an order for relief under chapter 7 of this title; (B) the conversion of a case under any chapter of this title to a case under chapter 7 of this title; or (C) the granting of relief from the stay provided under section 362(a)

• f this title with respect to aircraft, aircraft engines, propellers, appliances, or

spare parts, as defined in section 40102(a) of title 49, except for property of the debtor found by the court not to be necessary to an effective reorganization. (7) Any order entered by the court pursuant to paragraph (4) extending the period within which the trustee of an affected air carrier must assume or reject an unexpired lease of nonresidential real property shall be without prejudice to (A) the right of the trustee to seek further extensions within such additional time period granted by the court pursuant to paragraph (4); and (B) the right of any lessor or any other party in interest to request, at any time, a shortening or termination of the period within which the trustee must assume or reject an unexpired lease of nonresidential real property. (8) The burden of proof for establishing cause for an extension by an affected air carrier under paragraph (4) or the maintenance of a previously granted extension under paragraph (7)(A) and (B) shall at all time remain with the trustee. (9) For purposes of determining cause under paragraph (7) with respect to an unexpired lease of nonresidential real property between the debtor that is an affected air carrier and an airport operator under which such debtor is the lessee of an airport terminal

• r an airport gate, the court shall consider, among other relevant factors, whether

substantial harm will result to the airport operator or airline passengers as a result of the extension or the maintenance of a previously granted extension. In making the determination of substantial harm, the court shall consider, among other relevant factors, the level of actual use of the terminals or grates which are the subject of the lease, the public interest in actual use of such terminals or gates, the existence of competing demands for the use of such terminals or gates, the effect of the court s extension or termination of the period of time to assume or reject the lease on such debtor s ability to successfully reorganize under chapter 11 of this title, and whether the trustee of the affected air carrier is capable of continuing to comply with its obligations under section 365(d)(3) of this title. (10)(5) The trustee shall timely perform all of the obligations of the debtor, except those specified in section 365(b)(2), first arising from or after 60 days after the order for relief in a case under chapter 11 of this title under an unexpired lease of personal property

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(other than personal property leased to an individual primarily for personal, family, or household purposes), until such lease is assumed or rejected notwithstanding section 503(b)(1) of this title, unless the court, after notice and a hearing and based on the equities of the case, orders otherwise with respect to the obligations or timely performance thereof. This subsection shall not be deemed to affect the trustee s

• bligations under the provisions of subsection (b) or (f). Acceptance of any such

performance does not constitute waiver or relinquishment of the lessor s rights under such lease or under this title.