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Originally published in Reed Smith's Commercial Restructuring & Bankruptcy Alert, January 2006
Creditor Claims Subordination Upheld —SEC v. Great White Marine & Recreation, Inc., et al., 428 F.3d 553 (5th Cir. 2005)
A federally appointed receiver dissolved the defendant corporation on the grounds that it fraudulently distributed unregistered securities to investors. The receiver then created a disgorgement fund for equitable distribution to investors and creditors.
The U.S. Court of Appeals for the Fifth Circuit upheld the district court’s decision to subordinate the claim of a major creditor in favor of the defrauded investors because of the creditor’s inequitable conduct. Citing to the creditor’s knowledge of the receivership and of the court order staying all other actions against the corporation, the court found that the creditor willfully violated the stay order by initiating an involuntary bankruptcy proceeding against the corporation, wasting $100,000 in corporate assets before the bankruptcy case was dismissed. Recognizing that a district court has broad powers and wide discretion in equitable distributions for securities violations, the Fifth Circuit held that the district court did not abuse its discretion by equitably subordinating the creditor’s claim. As a result of willfully violating the stay order and the court’s decision to equitably subordinate its claim, the creditor received nothing on its $1 million claim.
Insurer Obtains Indemnity in Montgomery Ward Bankruptcy—Reliance Insurance Co. v. Colonial Penn Franklin Ins. Co. (In re Montgomery Ward & Co., Inc.), 428 F.3d 154 (3d Cir. 2005)
An indemnity agreement provided that the Forum Insurance Company was obligated to indemnify Reliance "from all loss and expense in connection with any Bonds executed on behalf of any one or more of the following persons, firms or corporations: Forum Insurance Company and Montgomery Ward & Co., Incorporated." Forum never defaulted on its bonds. Montgomery Ward, however, defaulted on its bonds to the tune of $40 million, an amount far in excess of the bond value that Reliance issued in favor of Forum. Reliance argued that the indemnity agreement unambiguously obligated Forum to indemnify against losses on any bond that Reliance issued to either Forum or Montgomery Ward. Forum argued that the indemnity agreement was ambiguous because it could mean that Forum was only obligated to indemnify against losses on bonds that Reliance jointly issued to Forum and Montgomery Ward.
The U.S. Court of Appeals for the Third Circuit held that the agreement was unambiguous because there was only one reasonable interpretation of its text. The court found Forum’s alternate interpretation unreasonable because Reliance never issued a joint bond to Forum and Montgomery Ward. Since that interpretation was "inconsistent with the very purpose for which the parties entered into the agreement," the court held that it could not create ambiguity in the text. Accordingly, Forum was obligated to indemnify the losses Reliance suffered on the defaulted Montgomery Ward bonds. The court noted that if Forum intended only to indemnify those bonds issued in its favor, "then surely it should have insisted that Montgomery Ward & Co., Incorporated be deleted" from the agreement because it was inconsistent with the parties’ intent.
Postpetition Administrative Fees—Weinstein, Eisen & Weiss, LLP v. Gill (In re Cooper Commons, LLC), Case No. 03-56818 (9th Cir., Sept. 13, 2005, amended Dec. 7, 2005)
Section 364(e) of the Bankruptcy Code encourages financial lenders to extend financing in a bankruptcy context by permitting reliance on a bankruptcy judge’s approval of a postpetition loan package. Specifically, section 364(e) states that if a lender extends financing in good faith and this financing is approved by the bankruptcy court, then the validity of this loan cannot be affected by a subsequent appeal. In In re Cooper, the trustee negotiated a postpetition loan from a bank that included a provision reserving a portion of the loan to pay the trustee and his staff.
Prior to the trustee’s appointment to oversee the estate, Cooper Commons, as debtor in possession, employed a law firm to provide services to the estate. The terms of the postpetition loan agreement excluded this firm from receiving any compensation under the new loan agreement. The law firm appealed, claiming that the court’s approval of the loan violated section 507(a)(1) which mandates equal treatment for all administrative claims. Affirming the district court’s ruling that denied the appeal, the Ninth Circuit held that reversing or modifying the approval of the loan package to mandate that the law firm share alongside with the trustee violated section 364(e). Since the Bankruptcy Court had approved the loan, and the lender had extended the financing in good faith and in reliance on the terms of the approved loan agreement which excluded the law firm from receiving compensation, forcing this amendment on the lender would affect the validity of the debt and violate section 364(e).
This article is presented for informational purposes only and is not intended to constitute legal advice.