The introduction in 2020 of subchapter V for small business chapter 11 cases was the biggest structural reform in business bankruptcies since the enactment of the Bankruptcy Code in 1978. Subchapter V was enacted in 2019 as part of the Small Business Reorganization Act and became effective in February 2020.  It was originally limited to cases with $2,725,625 or less in debt, but when Congress passed the CARES Act in 2020 in response to the COVID pandemic, it increased the subchapter V debt limit to $7.5 million. While that increase was originally scheduled to expire on March 27, 2021, it was extended through March 27, 2022.

Now there appears to be bipartisan support in Washington for making the $7.5 million debt limit permanent. Senator Charles Grassley, a ranking member of the Senate Judiciary Committee, who has had a long interest in reforms of the Bankruptcy Code, has said that he supports a permanent revision in the debt limit. Continue Reading Congress May Consider Making $7.5 Million Debt Limit for Subchapter V Permanent: Should the Limit Be Increased?

On November 22, 2021, the United States Bankruptcy Court for the Southern District of New York announced a modification to its judge-assignment scheme for “mega chapter 11 cases.” Under the new Local Bankruptcy Rule 1073-1(f), which took effect on December 1, 2021, mega chapter 11 cases will be randomly assigned among each of the district’s nine Bankruptcy judges irrespective of the courthouse in which the case is filed. A case will be considered a “mega” case if either the assets or liabilities of the debtor are at least $100 million (or in a multi-debtor case if the cumulative assets or liabilities meet the $100 million threshold). Under the old assignment rule, the case was randomly assigned among the judges sitting in a particular courthouse. The Southern District of New York has courthouses in New York City, White Plains, and Poughkeepsie.  

The announcement explains that the rule change “will result in a more balanced utilization of resources,” but it may also solve a perception problem. Under the old rule, large debtors could effectively hand-pick their judge by bringing the case in Poughkeepsie or White Plains, each of which has only one judge assigned: Robert D. Drain in White Plains and Chief Judge Cecelia G. Morris in Poughkeepsie.1 There is no doubt forum shopping in bankruptcy cases is a hot topic. We recently wrote about the Bankruptcy Venue Reform Act of 2021 introduced by Senators Elizabeth Warren (D-MA) and John Cornyn (R-TX) that would curb perceived venue shopping nationwide. This rule also brings SDNY in line with two other districts handling large volumes of corporate chapter 11’s, the District of Delaware (which only has one courthouse in Wilmington DE) and the Southern District of Texas (where pursuant to General Order 2018-1, complex chapter 11 cases are assigned randomly between two judges). 

The announcement by the United States Bankruptcy Court for the Southern District of New York can be found here: Modification in Assignment of Mega Chapter 11 Cases.

Some recent high profile restructuring debtors made multi-million dollar retention bonuses on the eve of bankruptcy filings. The U.S. Government Accountability Office (GAO) took notice of these pre-petition payments and, in September 2021, published a report with data showing that debtors may be “working around the [Bankruptcy] Code’s restrictions” by paying bonuses prior to filing bankruptcy. The GAO Report recommends that Congress amend the Bankruptcy Code to “bring pre-bankruptcy bonuses under court oversight” and “specify factors the court should consider before approving them.” And Congress listened and acted.

Historically, chapter 11 debtors routinely sought Bankruptcy Court approval to pay significant retention bonuses to key members of senior management pursuant to Key Employee Retention Plans or KERPs. Such “pay to stay” plans were essential, debtors argued, to retain key personnel to guide them through the restructuring. While KERPs were mainstream in large chapter 11 cases, creditor committees and other parties objected to these payments on the grounds that such payments (i) were unnecessary considering management’s ongoing fiduciary duties to creditors and shareholders, (ii) were inequitable considering the workforce reductions and wage and benefit sacrifices affecting the rank-and-file employees and (iii) enriched the very executives who drove the company towards chapter 11. Congress took notice and, in 2005, passed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) to impose strict limitations on such payments and to narrow the circumstances under which such payments could be made. (See Bankruptcy Code Section 503(c).)

While Congress took steps to restrict post-petition executive compensation, it took no action to restrict pre-petition executive compensation, creating a perceived loophole many recent large debtors sought to exploit. Indeed, the GAO Report found that in fiscal year 2020, $165 million in bonuses were paid to 223 executives across 42 companies shortly before they filed for bankruptcy.

In October 2021, Rep. Cheri Bustos (D-IL-17), proposed the No Bonuses in Bankruptcy Act of 2021 (the “Act”) which, as the name suggests, proposes amendments to the Bankruptcy Code to prohibit certain bonus payments. The Act proposes two categories of changes: First, the Act would add a subsection (d) to section 503 prohibiting bonuses for (i) individuals whose annual salaries exceed $250,000, (ii) insiders of the debtor, or (iii) any individuals to the extent that a bonus would cause that individual’s annual salary to exceed $250,000. The Act defines bonus to include “retention, incentive, or reward related services” provided to a debtor, but excludes sales commissions and obligations under collective bargaining agreements. The Act specifies that the term “individual employed by the debtor” includes, but is not limited to, employees, consultants, and contractors of the debtor. Second, the Act directly targets companies who wish to award pre-filing bonuses by revising Bankruptcy Code Section 547 to allow avoidance of any transfer made within 180 days before the bankruptcy petition is filed “if such transfer is the payment of a bonus of the kind that would be disallowed under subsection (c) or (d) of section 503.”

Whether a practitioner believes Section 503 unduly restricts executive compensation or does not restrict executive compensation enough, the GAO Report and the Act indicate that significant changes may be forthcoming. As with the Bankruptcy Venue Reform Act of 2021, which also proposes robust changes to the Bankruptcy Code for corporate debtors, Herrick will continue to monitor this legislation.

The GAO’s report may be accessed here: September 30, 2021 GAO Report.

The text of the Act may be found here: No Bonuses in Bankruptcy Act of 2021.

 

The Supreme Court declined to take up a case this month concerning the doctrine of equitable mootness, a topic that continues to rile bankruptcy courts and generate controversy amongst practitioners and scholars. The Eighth Circuit Court of Appeals recently described the doctrine as one that is “misleadingly” labeled, but which allows courts to dismiss an appeal from a bankruptcy court’s ruling because the appeal has been rendered moot due to “equitable, prudential, or pragmatic considerations.” In most situations, the appeal is “equitably” moot because the bankruptcy court’s order has already been implemented by the debtor by the time the appeal is heard. Meanwhile, in bankruptcy cases big and small, appeals primarily from confirmation plans are focused on the issue. With Courts of Appeals divided on the issue, it will continue to generate objections, expedited appeals, and uncertainty going forward. Continue Reading Equitable Mootness Doctrine Will Continue to Generate Controversy After Supreme Court Declines to Hear Appeal on the Issue

On September 23, 2021, United States Senators Elizabeth Warren (D-Mass.) and John Cornyn (R-Texas) introduced the Bankruptcy Venue Reform Act of 2021 (the “Venue Reform Act”), which would tighten the Bankruptcy Code’s venue rules for corporate debtors. A corporate filer would be limited to the district containing its principal place of business or the district where its principal assets have been located for the preceding 180 days. For a public company, the location listed in its SEC filings would be its presumptive principal place of business. The Venue Reform Act is intended to eliminate forum shopping by corporate debtors seeking to file their chapter 11 cases in traditionally debtor-friendly courts.  

This blog post describes some of the main changes that would go into effect if the Venue Reform Act were approved. The full text of the proposed Venue Reform Act may be found here: https://www.warren.senate.gov/imo/media/doc/SIL21A87.pdf.   Continue Reading What the Bankruptcy Venue Reform Act of 2021 Could Mean for Corporate Debtors

Federal district court judge Paul Gardephe recently spared Keleil Isaza Tuzman from additional jail time, despite Tuzman’s December 2017 convictions for securities and mail fraud, the latest twist in the long, strange saga of KIT Digital. Tuzman was the founder and former CEO of KIT Digital Inc., a publicly traded software startup that offered video management products, but which ended up bankrupt and is now called Piksel Inc. The US Attorney sought a prison term of 17.5-22 years for Tuzman.

Tuzman, and co-defendant Omar Amanat, who was sentenced to five years in jail and fined $175,000, were convicted on multiple counts of manipulating the stock price for KIT Digital and for defrauding investors in a hedge fund known as Maiden Capital. Continue Reading Judge Spares Ex-CEO of Bankrupt KIT Digital from Additional Jail Time

The House of Delegates for the American Bar Association recently passed Resolution 512 urging Congress to amend the Bankruptcy Code to permit student loans to be discharged in bankruptcy without proving “undue hardship” as is currently required. The resolution was co-sponsored by the Young Lawyers Division, the Law Student Division and the Standing Committee on Paralegals. The Young Lawyers Division submitted a report in support of the resolution (the “YLD Report”) which discussed the history of student loans and borrowers’ ability to discharge them bankruptcy.

There is no question discharging student debt in bankruptcy is a hot political topic worthy of ABA attention. The Biden administration has forgiven over $9 billion in student debt and many congressional leaders call for complete student debt forgiveness. Since March 27, 2020, pursuant to the Coronavirus Aid, Relief and Economic Security Act, repayment of federal loans has been frozen. The freeze was extended several times and will not expire until at least January 31, 2022. We also wrote about the recent Second Circuit decision—Homaidan v. Sallie Mae, Inc.—which will make it easier for borrowers to discharge certain student debt in bankruptcy, even under existing law. The YLD Report explains how young lawyers are particularly affected: the average debt for law school graduates is around $145,000 (although the default rate for law school grads is traditionally better than the pre-freeze 11% figure for all student loan borrowers). Continue Reading Discharging Student Loan Debt: The ABA Takes a Stand

Student loans are a big issue in the United States. According to the most recent data by the Federal Reserve Bank of New York, there is currently $1.57 trillion in outstanding student debt, up from just $0.26 trillion 17 years ago.[1] Before the CARES Act suspended payments and interest accruals from August 2020-January 2022, student debt holders were also the most likely borrowers to be 90+ days delinquent, hovering around 11% from 2012 – 2019. Current bankruptcy law makes the discharge of most student loans extremely difficult; the borrower has to establish “undue hardship,” a term not defined in the Bankruptcy Code, but which has been interpreted very strictly against student borrowers. The stratospheric rise in total student debt has many causes, but the exemption from discharge in bankruptcy for student debt is one of the more contentious. After a recent decision by the Court of Appeals for the Second Circuit, the extent of that exemption may be narrowing. Continue Reading Discharging Student Loan Debt – Private Loans Are Not Always Exempt

The U.S. Bankruptcy Court for the District of Delaware recently denied the US Trustee’s motion to compel post-confirmation quarterly fees from Paragon Offshore, plc under 28 U.S.C. § 1930.[1]

The court described the case’s facts as simple: Paragon (and some related entities) filed for Chapter 11 in early 2016. In June of 2017, its reorganization plan was approved. The plan established a litigation trust (the Paragon Litigation Trust) to pursue certain claims against third parties. The plan (and the litigation trust agreement) became effective in July of 2017, and the claims were transferred into the trust from July through September 2017 (without Paragon retaining any interest in or control over them). During that time, Paragon’s distributions exceeded $623 million, and Paragon paid the US Trustee the then-applicable maximum fee for those distributions under 28 U.S.C. § 1930.

In December of 2017, the litigation trust brought its claims against third parties. The case settled for $90.375 million (approved in February of 2021), and the settlement payments to the trust occurred in mid-March. The trust began distributing those payments to its beneficiaries, and the US Trustee moved to compel Paragon and the Paragon Litigation Trust to pay post-confirmation quarterly fees under Section 1930(a)(6) based on the trust’s payments to its beneficiaries. Continue Reading Paragon Offshore, plc: US Trustee Denied Quarterly Fees Based on Litigation Trust’s Payments to Its Beneficiaries

Philadelphia Entertainment and Development Partners LP, the bankrupt limited partnership that did business as Foxwoods Casino Philadelphia (“Foxwoods”), will not be able to recover the $50 million it paid to the Pennsylvania Gaming Control Board for a slot machine license. Foxwoods planned to open a sizable slot machine facility in Philadelphia and paid for the license in 2007 before its location was final. Neighborhood opposition forced substantial delays and when Foxwoods missed a series of deadlines the Board revoked the license in December 2010.

Foxwoods filed for bankruptcy in 2014 after it unsuccessfully tried to get the license back in state court. In bankruptcy court, it brought a fraudulent transfer claim against the Commonwealth of Pennsylvania to recover the payment it made for the revoked license. The claim was initially dismissed in 2016, remanded on appeal, and then dismissed by the Eastern District of Pennsylvania on sovereign immunity grounds. Foxwoods appealed again, arguing it had a property interest in the revoked license. A sovereign immunity defense is not available in cases that further a bankruptcy court’s in rem jurisdiction. In other words, if Foxwoods had a property interest in the revoked license, the claim could move forward. Continue Reading Recovering a Fraudulent Transfer? A Slot Machine License Is No Safe Bet.