- within Transport topic(s)
Ninth Circuit Joins Eleventh, Holds There Is Federal
Common Law Of Receivership
By Mike C. Buckley
The U.S. Court of Appeals for the Ninth Circuit has held that there is a federal common law of receivership in the context of real property security interest, joining the Eleventh Circuit. Can. Life Assurance Co. v. LaPeter, 557 F.3d 1103 (9th Cir. 2009).
While most states have their own receivership statutes, federal law does not have a parallel statutory scheme. Federal Rule Civil Procedure 66 recognizes historical federal receivership practice but does not define the circumstances under which a receiver should be appointed. LaPeter, an appeal from a decision by the federal District Court of Idaho, clearly establishes for the first time in the Ninth Circuit that a receiver can be appointed in a diversity action to aid in the enforcement of a real property security interest.
LaPeter (a family trust) purchased a shopping center in Boise, Idaho, with financing from Canada Life. After several years, LaPeter approached Canada Life with a request to refinance the loan at a lower rate of interest. During the negotiations, LaPeter made representations about the shopping center's projected income and the status of negotiations over renewal of several of the tenants' leases. After committing to the loan, Canada Life discovered that the representations were false and cancelled its refinancing agreement.
LaPeter failed to find alternative financing and defaulted. Canada Life initiated a nonjudicial foreclosure against the property and filed an action in Idaho state court, seeking the appointment of a receiver to manage the shopping center and collect the rents pending foreclosure. LaPeter removed the case to federal court on diversity grounds.
Receiver Appointed
The federal district court appointed a receiver with responsibilities typical of those appointed in the shopping center context: to manage and rent the property, collect the rents, provide insurance, provide maintenance and upkeep, and account for the income and disbursements. The district court made findings that tracked the requisites of the Idaho state receivership statute. Even so, the district court did not articulate whether it was relying on the federal common law or state statutory law to justify the appointment.
LaPeter appealed, and the Ninth Circuit affirmed.
The question as to what standards should be applied to justify the appointment of a federal receiver in a diversity action has not been fully addressed by the circuit courts. The Eleventh Circuit's decision in Nat'l P'ship Inv. Corp. v. Nat'l Hous. Dev. Corp., 153 F.3d 1289 (11th Cir. 1998) concluded that federal common law governed the appointment of federal receivers in a diversity case. The Ninth Circuit in LaPeter followed suit and went on to articulate the legal standards governing the appointment.
The court acknowledged that no single factor determined whether a receiver should be appointed. Instead, a number of factors need to be considered to make a decision.
The factors articulated by the court should come as no surprise to receivership lawyers. The court listed these circumstances to be considered, no one of which is dispositive:
- Is there a substantial probability that the plaintiff has a valid claim?
- Has there been fraudulent conduct and how certain is the proof of that conduct?
- Is the property at risk of being concealed or damaged, or is it declining in value pending the foreclosure?
- Are the legal remedies available to the plaintiff inadequate to protect its security interest in the property?
- Where does the balance of equities point – does the injury to the secured creditor from allowing debtor uncontrolled use of the property outweigh the injury to the debtor as a result of the appointment of the receiver?
- Is the receiver the best remedy for the evils being considered – would a writ of attachment or some other procedure be more effective or fair?
Managing Real Property
In a 1960 opinion, the Ninth Circuit established additional factors that must be established in order to fully empower the receiver to manage real property collateral as opposed to just controlling the rents. In Viewcrest Garden Apartments, Inc. vs. U.S., 281 F.2d 844 (9th Cir. 1960), the court held that the plaintiff needed to show the doubtful financial standing of the defendant, the over-encumbered status of the property, and typically something in addition, such as the defendant's deliberate conduct to allow the property to deteriorate. LaPeter leaves these requirements in place.
Accordingly, the Ninth Circuit affirmed the district court's order appointing a receiver.
Finally, as in many federal common law contexts, the court had to grapple with the Erie Doctrine. Is a receivership in a diversity case a substantive or a procedural matter? If substantive, state law applies; if procedural, federal law does. In LaPeter, the Ninth Circuit determined that receivers were essentially procedural tools used to keep the status quo while the parties' substantive rights were determined under applicable state law.
Here, the claims over the alleged breach of contract claims by LaPeter against Canada Life were seen as substantive, but the court had no trouble concluding that Canada Life's foreclosure on its deed of trust and the associated receivership were procedural matters. So a federal common law of receivership did not violate the Erie Doctrine.
Going Forward
The LaPeter decision may open up an additional opportunity for a party considering an application for a receivership. In some states, the state receivership law may be less favorable to the applicant than the nationwide federal common law of receivership articulated in LaPeter. If diversity jurisdiction is available over the defendant there, the federal court might be a better place to apply.
BAP Decision In City Of Vallejo Chapter 9 Case Becomes
Final
By Mike C. Buckley
An opinion issued earlier this year by the Ninth Circuit Bankruptcy Appellate Panel in the largest municipal bankruptcy since Orange County has become final.
The BAP decision in the City of Vallejo, California, case became final when the appellant city labor unions voluntarily withdrew their further appeal to the Ninth Circuit. The appeal to the BAP had followed an eight-day bankruptcy court trial over whether Vallejo was eligible to be a chapter 9 debtor. On June 26, 2009, the BAP issued an opinion affirming the bankruptcy court's determination that Vallejo was eligible.
The BAP opinion resolved four significant issues in municipal bankruptcy law raised in the bankruptcy court. These were whether:
- Vallejo was "insolvent" under the provisions of Bankruptcy Code section 109(c)(3)
- Vallejo had demonstrated that it desired to effect a plan to adjust its debts under section 109(c)(4)
- Vallejo had negotiated with its creditors in good faith as required by section 109(c)(5)(B)
- In the alternative to (3), Vallejo was unable to negotiate with its creditors because doing so was impracticable under section 109(c)(5)(C)
The bankruptcy court found that Vallejo was insolvent, it desired to effect a plan, and it was unable to negotiate with its creditors because to do so was impracticable.
BAP Decision
The BAP affirmed, holding that Vallejo was insolvent and desired to effect a plan of adjustment. Int'l Assoc. of Firefighters v. City of Vallejo (In re City of Vallejo), Ch. 9 No. 08-26813, Ad. No. 08-1244 (B.A.P. 9th Cir. June 26, 2009).
The BAP did hold, however, that Vallejo had not met the requirement to negotiate with its creditors in good faith under section 109(c)(5)(B). Nonetheless, the BAP affirmed the order, deeming Vallejo eligible to be a chapter 9 debtor by holding that Vallejo had met the alternative test of impracticability of negotiating with creditors under section 109(c)(5)(C). Thus, Vallejo was eligible to be a debtor under chapter 9.
First, the BAP addressed whether Vallejo had demonstrated that it was "insolvent" within the meaning of section 101(32)(C)(ii), which defines insolvency in the case of municipalities as the inability to pay debts as they become due, or the failure to pay debts as they become due. The BAP approved the bankruptcy court's adoption of a cash flow analysis as the means to test insolvency. Vallejo contended that it would be unable to pay its debts as they became due during the next year because its cash flow was insufficient to meet its budgeted obligations.
The appellant labor unions argued Vallejo's balance sheet showed that substantial cash reserves were available to fund its operations and pay its obligations as they fell due. Vallejo contended most of its cash was held in funds that were restricted by law or contract, and was unavailable for payment of general fund obligations.
The appellants also contended that Vallejo could solve its budget problems by making substantial budget cuts. They argued the city should reduce its staffing, and accept what Vallejo viewed as a draconian offer by the appellants to significantly reduce labor costs in the short term in return for guaranteed increases in coming years.
The bankruptcy court rejected the appellants' arguments and found Vallejo insolvent. The BAP affirmed.
Funding Sources
While Vallejo did not attempt to examine restrictions on each of the many separate funds it maintains in its accounting records, the city did present evidence that only the so-called general fund was available to supply resources to meet the city's expenditure needs. Vallejo's cash flow projections for its general fund indicated the city would not be able to pay its obligations throughout the next fiscal year.
The BAP found the evidence sufficient to show that because the general fund was not balanced, Vallejo was insolvent. This focus by the BAP demonstrates the importance in a chapter 9 case of a clear understanding of municipal accounting.
Municipal accounting is not based upon GAAP, but instead upon a separate set of standards established by the Governmental Accounting Standards Board (GASB). Because of the way in which governments borrow money and organize repayment, many separate funds are devoted to specific purposes and can only be used for these purposes.
It is not unusual for a municipal activity such as a city's water supply system to accumulate cash in excess of the amount needed to operate that system and pay the bond debt borrowed to build or improve the system. This was true in Vallejo's case; the use of certain disputed funds was restricted by the bond documents to water department-related expenditures.
While municipal accounting standards do allow a city to borrow from one of its specialized funds, it may do so only if it clearly will have the ability to repay that borrowing during the ensuing fiscal year. Vallejo's inability to balance its budget, negative cash flow, and projections of falling tax and other municipal revenue prevented the city from being able to borrow from the special funds to pay general expenses.
Accordingly, the BAP found that the restrictions on the special funds precluded the city from using cash from those funds to augment its ailing general fund.
Budget Cuts
Appellants also argued that Vallejo was obligated to try to stay out of bankruptcy by cutting its budget as much as was necessary. They argued that at some reduced level of public services, the budget would be balanced, cash would be available and no insolvency would occur.
The BAP, however, accepted the bankruptcy court's finding that cutting the budget to the level required to avoid "insolvency" defied fiscal prudence, and would leave the city more financially debilitated and even less able to face the next fiscal year.
The appellants' final suggestion to balance the budget was the appellants' offer to temporarily amend the public employee collective bargaining agreements so that the budget for the current fiscal year could be balanced. The offer, however, was premised on substantial future concessions by the city, which appellants argued the city could perform as its revenues recovered.
The city argued that such short-term fixes undermined the city's long-term solvency, and the city was not required to defer significant budgetary issues by short-term stop-gaps to stay out of bankruptcy.
The BAP approved the bankruptcy court's deference to the political judgment of the city about how much public service could be cut from the current budget, and whether deferring the problems was preferable to a present chapter 9 filing. Taking all of this into consideration, the BAP determined that the bankruptcy court's findings were supported by the evidence in the record, and it had correctly determined that Vallejo was insolvent as defined in the Bankruptcy Code.
Reorganization
With respect to whether Vallejo desired to effect a plan of reorganization, appellants contended that the records showed that Vallejo did not desire to effect a plan but was instead engaged in union busting.
The BAP observed that Vallejo is required by law to adopt its annual budget by a certain date and that it must be a balanced budget. Vallejo had negotiated with its creditors virtually up to the deadline before filing the bankruptcy petition. The protracted effort to reach an accommodation demonstrated Vallejo's desire to effect a plan of adjustment in some fashion.
Finally, appellants argued that Vallejo failed to negotiate in good faith with its creditors before filing its bankruptcy petition.
To avail itself of Bankruptcy Code section 109(c)(5)(B), a municipality must have negotiated in good faith with its creditors, but have failed to obtain an agreement with creditors holding at least a majority of the amount of claims in each class that the city intends to impair under its bankruptcy plan.
The bankruptcy court found that Vallejo had in fact negotiated in good faith with such parties.
On appeal, the appellants argued that section 109(c)(5)(B) requires that the city negotiate over the terms of a specific plan, or at least a detailed outline of one. The city conceded that during the negotiations it did not have a specific plan or even a detailed outline to present.
The BAP found in favor of the appellants on this point, noting that it was influenced by language in the Bankruptcy Code that persuaded it that a specific plan or detailed outline was required. Because there was none, the BAP held that the bankruptcy court erred in finding that the city met the requirements of section 109(c)(5)(B).
The BAP went on, though, to find that error harmless because the city had met the alternative test under section 109(c)(5)(C). Vallejo was not required under 109(c)(5)(C) to negotiate with its creditors if such negotiation was "impracticable." Vallejo's evidence showed that the number of creditors in multiple classes and the need to file a petition quickly as the deadline for a balanced budget loomed were indicators of impracticability.
For example, the bankruptcy court found, and the BAP agreed, that Vallejo could not meaningfully negotiate with its largest single creditor—Union Bank—because the bank took the position that it would not renegotiate its loan terms unless the city could submit a viable long-term financial plan based on adjustments to its labor costs. Because Vallejo was not able to reach agreement with its unions, it was not in a position to negotiate with its largest single creditor.
The bankruptcy court also noted that Vallejo was justified in declining to negotiate with its retirees, who held claims of more than $200 million, or the many bondholders of the numerous issues of Vallejo's bonded debt, because of the city's inability to actually identify the retirees or the holders. The conclusion was that Vallejo could not practically negotiate with creditors that it would have to impair under any reasonable plan.
Thus, Vallejo was deemed to be an eligible debtor under chapter 9.
Delaware Court Modifies Stub Rent Stance
By Claudia Z. Springer
The U.S. Bankruptcy Court in Delaware recently issued an opinion that appears to alter, in part, its earlier decision regarding the administrative status of stub rent.
In the July issue of the Commercial Restructuring & Bankruptcy Alert, we reported on the opinion in the Goody's Family Clothing case regarding the administrative expense status of rent owed by a debtor's estate for the time period immediately following the petition date, and prior to the date when the next rent payment is due—the so-called "stub period." See Goody's Family Clothing, Inc. v. Mountaineer Prop. Co. II, LLC (In re Goody's Family Clothing, Inc.), 401 B.R. 656 (D. Del. 2009); CR&B Alert, July 2009, p. 8, "Landlord Can Seek Payment for Use During 'Stub' Period."
In a new opinion by the same bankruptcy judge who decided the Goody's case, the court altered its view, at least in part, regarding the allowance of stub rent as an administrative claim and the calculation of the administrative claim. In Sportsman's Warehouse, Inc., the court was asked to opine not only about the stub rent, but also to determine whether real estate taxes, payable by the debtor-tenant under certain of it leases, constituted an administrative claim when that rent was for periods that preceded the chapter 11 filing, but was billed by the taxing authorities to the landlord and was payable by the tenant under the leases after the bankruptcy filing. In re Sportsman's Warehouse, Ch. 11 No. 09 10990 (D. Del. Aug. 3, 2009).
In Sportsmen's Warehouse, the debtor, a retail sporting goods chain, filed its bankruptcy case March 21, 2009. The debtor was the tenant under numerous leases, including the three that are the subject of the court's decision. Under all three leases, the debtor was responsible for paying the real estate taxes associated with the property.
Lease Rejection
The leases were rejected by the debtor soon after the bankruptcy filing, two as of April 30, 2009 and one as of May 31, 2009. With respect to one of the two leases rejected April 30, 2009, the local taxing authority issued a Real Estate Tax Statement March 31, 2009 covering the period between July 1, 2008 and Dec. 31, 2008. That statement provided that payment was due May 13, 2009. With respect to the lease rejected May 31, 2009, the taxing authority sent the landlord a tax bill for the period between July 1, 2008 and Dec. 31, 2008, providing that taxes would be delinquent if not paid by June 20, 2009.
All three landlords sought allowance of an administrative claim for the "stub rent" period in amount equal to the rent payable under the leases between the bankruptcy petition date and the next rental payment date as well as an administrative claim for the real estate taxes that accrued between the petition date and the date the leases were deemed rejected. None of the landlords was billed for the real estate taxes that accrued during this period.
The Sportsmen Warehouse court noted that under the well-settled law of Montgomery Ward, any rent that was due pre-petition could not be treated as an administrative claim under Code section 365(d)(3); however, as in Goody's, the court observed that another avenue of similar recovery for a landlord with a stub rent claim was Code section 503(b)(1), which provides administrative claim status to claims for actual and necessary expenses of preserving an estate.
In Goody's the issue was whether the landlords could recover their stub rent claims as administrative expense claims. There was no dispute as to the amount of the claim, which everyone agreed was the amount of rent due under the lease during the stub rent period. The Goody's court found that the landlords held an administrative expense claim under 503(b)(1), not 365(d)(3), because the use and occupancy of the premises by the debtor per se provided a benefit to the estate. In this case, however, the court altered its opinion rendered in Goody's by finding that while the debtor's occupancy of leased premises during that "stub" period may have conferred a benefit to the estate, the amount of such benefit was not per se the amount of the fair market value of the occupancy.
Thus, landlords are not necessarily entitled to an administrative claim for use and occupancy under 503(b)(1) equivalent to the fair market value of the occupancy, but rather they must prove the amount of the benefit conferred upon the estate. The court must analyze the evidence submitted to it and determine on a case-by-case basis the amount of benefit conferred upon the estate to determine the appropriate amount of the landlord's administrative expense claim.
Tax Claims
As to the claim for unpaid real estate taxes, the court found that pre-petition taxes would be payable as an administrative expense only if the debtor's obligation to pay such taxes arose post-petition and prior to the rejection of the leases. If the lease at issue provides an exact due date for the taxes, that date is easily established. In this case, the leases provided that the taxes were payable prior to the date when a penalty would arise for late or non-payment. That date did not occur until after the leases were rejected, and thus the court found that the claims for the taxes were not entitled to administrative claim status.
New York Ruling Extends Tax Exemption In Bankruptcy
Sales
By John L. Scott, Jr.
The U.S. Bankruptcy Court for the Southern District of New York issued a decision earlier this year that is likely to have a significant impact on bankruptcy sales of property. In In re New 118th, Inc., 398 B.R. 791 (Bankr. S.D.N.Y. 2009), the court held that certain tax exemptions available pursuant to section 1146(a) of the Bankruptcy Code in connection with transfers of property that occur "under a plan," apply to pre-confirmation sales that close after confirmation and are necessary to the consummation of the debtor's plan.
In New 118th, the trustee contracted to sell 21 apartment buildings in New York City owned by the debtors for $54 million (the "Sale"). The contract of sale provided that the Sale was "expressly conditioned upon the entry of an order pursuant to Section 363 of the Bankruptcy Code, or pursuant to a confirmed Chapter 11 plan ...." Subsequently, the trustee moved under section 363 of the Bankruptcy Code for court approval of the Sale and argued that, although he was seeking court approval prior to filing a plan and disclosure statement with the court, the Sale was integral to the consummation of the anticipated plan.
Therefore, the trustee argued that the property being sold should be exempt from stamp and similar taxes pursuant to section 1146(a), which provides that "[t]he issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under section 1129 of this title, may not be taxed under any law imposing a stamp or similar tax." 11 U.S.C. § 1146(a).
The New York City Department of Finance (the "City") objected, arguing that section 1146(a) does not apply to pre-confirmation sales, and that the trustee agreed to escrow the disputed taxes until the issue of the exemption was resolved by the court.
The Plan
Thereafter, the trustee filed a plan of liquidation that proposed to pay administrative and priority claims in full on the effective date, and distribute any remaining amounts to general unsecured creditors. The plan reiterated that the Sale was an "integral part of implementation of the Plan" and that the Sale would be exempt "from the imposition of any New York state or local deed recording taxes and other similar taxes."
The City filed a limited objection to the plan again contending that section 1146(a) was inapplicable to the Sale, and that the City was entitled to more than $1.6 million in taxes. In support of its objection, the City relied on the decision in Fla. Dep't of Revenue v. Piccadilly Cafeterias, Inc. ("Piccadilly"), 128 S.Ct. 2326 (2008), in which the Supreme Court held that the Section 1146(a) exemption did not apply to a Section 363 pre-confirmation sale, even if the sale closed post-petition.
The court confirmed that plan and reserved decision on the applicability of the tax exemption. The Sale closed approximately one month later. At the closing, the trustee executed and delivered the deeds, and the purchaser recorded the deeds approximately two weeks later.
The court ultimately denied the City's objection and held that the Sale qualified for the section 1146(a) exemption. As the court held, the "§1146(a) exemption applies to a post-confirmation transfer that follows a pre-confirmation sale if the transfer facilitates the implementation of the plant, or ... is necessary to the consummation of the plan." Relying on New York law, which provides that the transfer of real property does not occur until the deed is delivered and accepted, the court found that the transfers occurred post-petition because the deeds were delivered post-confirmation.
While acknowledging the Supreme Court's holding in Piccadilly, that section 1146(a) "is inapplicable to pre-confirmation transfers," the New 118th court found that post-confirmation delivery of the deed in connection with a sale that occurred pre-confirmation – an issue not addressed by the court in Piccadilly – satisfies Piccadilly's "simple, bright line rule."
Counsel's Corner
News From Reed Smith
Firm's Bankruptcy Practice is Top Ranked in Legal Pubs
Reed Smith earned recognition as a "Top Ranked" firm in the annual rankings released by Chambers USA: America's Leading Lawyers for Business. Firm lawyers earning a Band 1 ranking in Bankruptcy & Restructuring include Delaware partner Kurt F. Gwynne, Pittsburgh partner Paul M. Singer and Philadelphia partner Claudia Z. Springer.
Firm lawyers who ranked among the nation's best in the area of Bankruptcy & Restructuring in Chambers' 2009 national and state-by-state assessments include Chicago partner Stephen T. Bobo, Philadelphia partner Peter S. Clark II and Pittsburgh partner Eric A. Schaffer.
The 2009 issue of the Legal 500 also recognized a number of Reed Smith lawyers as leaders in the area of commercial restructuring and bankruptcy. New York partner Jeffrey L. Glatzer was recognized for his work in Finance/Bankruptcy, and J. Andrew Rahl, Jr., also a New York partner, was recognized for his work in the areas of Finance/Bankruptcy and Structured Finance: derivatives and structured products.
In Print
Paris partner Anker Sorensen and Paris associate Sophie Borenstein published "New French Incentives Help Corporations Weather the Economic Storm," in Tax Notes International, 24 August 2009, pp. 651-653.
Anker also published an article with Paris counsel Andrew Tetley, "Making France a More Attractive Forum for Restructuring in Europe – Part 1," in the ABI Journal, September 2009. Part 2 will be published in the November issue of the same journal.
Andrew also was a contributing author to World Insolvency Systems: A Comparative Study, published in June 2009. He authored the French chapter in the book, which compares 17 jurisdictions in insolvency and bankruptcy-related matters.
Speakers Bureau
Paris partner Anker Sorensen has been invited to speak at the American Bankruptcy Institute in Paris Oct. 9.
To return to part 1 of this article please click 'Previous Page' below.
This article is presented for informational purposes only and is not intended to constitute legal advice.