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Business Law Today

June 2023

June 2023 in Brief: Bankruptcy & Finance

Janet Scoles Nadile, Megan M Adeyemo, and Linda W Filardi

June 2023 in Brief: Bankruptcy & Finance
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Bankruptcy Law

Last Minute Pre-Effective Date Contract May Be Unenforceable Against Reorganized Debtor

By Michael Enright

In its landmark decision in NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984), the Supreme Court rejected the notion that a debtor-in-possession is a new legal entity that springs into being upon the petition date. Nonetheless, the idea that the pre-petition debtor, the debtor-in-possession, and the reorganized debtor should be treated as if they are separate entities remains a convenient way to think about the different bundles of legal rights and obligations of the entity that becomes a debtor when it enters chapter 11 and then reorganizes. Judge Goldblatt effectively used that tool in a recent decision in Mesabi Metallics Company LLC v. B. Riley FBR, Inc. (In re Essar Steel Minnesota, LLC), Adv. No. 18-50833 (CTG) (Bankr. D. Del. June 23, 2023). In Essar Steel, the essential allegation in the adversary proceeding complaint was that the day before the plan became effective, the debtor and the entity that acquired it under the plan entered into an engagement with an investment banker that purported to bind the debtor after the effective date to pay a fee to the investment banker for capital it would subsequently raise for the debtor. The reorganized debtor asserted that the investment banker’s attempts to collect a success fee of $17 million based on its post-effective date efforts to raise the capital violated the discharge injunction and were barred by the terms of the plan. The investment banker moved to dismiss the complaint, arguing that it failed to state a claim, and that the reorganized debtor’s post-emergence actions had the effect of binding it to the pre-effective date contract. Judge Goldblatt denied the motion to dismiss, analyzing the facts and timing while utilizing a framework that carefully considered the legal issues as if there were three fictional but separate entities involved where the debtor was concerned. In the ruling, the court relied on the discharge provisions of the confirmed plan, the nature of a bankruptcy “claim” and when it arises under Third Circuit precedent, and the express terms of the plan injunction in denying the motion to dismiss. The adversary proceeding will proceed. Unless settled, it is likely to generate an interesting decision on whether the reorganized debtor effectively ratified and adopted the pre-effective date contract through its further actions, as well as the benefits it may have received, in connection with raising the capital. In the meantime, courts will continue to rely on the fictional separateness of the pre-petition debtor, the debtor-in-possession, and the reorganized debtor as a helpful framework for analysis, hopefully while keeping the Bildisco ruling in mind, as Judge Goldblatt apparently did.

Could the Characterization of Fixed Charges Be Approached with Greater Latitude Following the UK High Court’s Decision in Re Avanti Communications?

By Sam Furse, Osborne Clarke

In Avanti Communications  the court interpreted the degree of control required to characterize certain charges as fixed charges with greater latitude than previously understood. Avanti concerned security held over certain satellite equipment and intangible assets, following Avanti’s entry into administration.

Fixed charge security is advantageous to chargees as, among other things, it provides enhanced priority when a chargor enters a formal insolvency procedure, potentially strengthening recoveries given that only the costs of realization are deductible. Conversely, floating charges rank behind (i) fixed charge realizations, (ii) moratorium-related liabilities, (iii) certain insolvency expenses, (iv) preferential debts, and (v) the prescribed part (a percentage of floating charge realizations retained for unsecured creditors).

Before Avanti, academic commentary and most practitioners considered that only a total prohibition on disposal or release of assets from security without the chargee’sactive concurrence" was consistent with characterizing a security interest as fixed charge security, based on an interpretation of the House of Lord’s decision in Spectrum Plus.

While in most circumstances Avanti’s freedom to deal with the relevant assets without the chargee’s consent was “materially and significantly limited,” with practically no ability to release or dispose of them in the ordinary course of business, Avanti did retain certain rights to freely sell the relevant assets depending on, among other things, their market value and continued usefulness to the business. Nevertheless, the relevant assets were considered subject to fixed charges.

Time will tell whether judges follow this more nuanced approach going forward, as Avanti is a first instance decision which may be distinguished and limited to its own facts. Nevertheless, secured creditors will hope that the court considers characterization with greater latitude than taking an “all or nothing” approach.

The Supreme Court Speaks: PROMESA Board Has Sovereign Immunity in Response to Puerto Rican Media Organization

By Jinxin Sun

On May 11, 2023, the U.S. Supreme Court announced its decision in Financial Oversight and Management Board for Puerto Rico v. Centro de Periodismo Investigativo. In an 8-1 ruling, the U.S. Supreme Court ruled against Centro de Periodismo Investigativo, a Puerto Rican media organization seeking access to documents from Puerto Rico’s Financial Management and Oversight Board.

In response to a fiscal crisis precipitated by skyrocketing public debt in Puerto Rico, Congress passed the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) in 2016. PROMESA creates the Financial Oversight and Management Board (the Board) for the Commonwealth of Puerto Rico.

PROMESA enables the Commonwealth to gain bankruptcy protections comparable to those available under the Federal Bankruptcy Code. PROMESA’s Title III provides a path to restructuring debt that is similar to the United States Bankruptcy Code. Puerto Rico’s creditors are separated into groups based on the different legal rights and priorities associated with their claims. The Board is empowered to negotiate plans of adjustments to lower Puerto Rico’s debt to sustainable levels, subject to a confirmation process by the federal court. That is, the Board represents Puerto Rico in judicial debt restructuring proceedings modeled on federal bankruptcy proceedings.

Centro de Periodismo Investigativo, Inc. (CPI), a nonprofit media organization, has reported on Puerto Rico’s fiscal crisis since 2016. CPI sued the Board to gain access to various Board documents relating to its work, access that the Board had previously denied. In its decision, the Supreme Court reversed the lower courts’ findings that PROMESA Section 2126(a) abrogated the Board’s sovereign immunity and that CPI could sue the Board. Writing for the majority, Justice Elena Kagan stated that nothing in PROMESA makes clear that Congress deprived the Board of sovereign immunity, and accordingly, the Board retained its immunity from suit.

In the District Court action, CPI cited the Puerto Rican Constitution that has been interpreted to guarantee a right of access to public records, and it requested an injunction ordering the records’ release. The Board moved to dismiss the suit on the grounds that, as an arm of the Puerto Rican government, it enjoys sovereign immunity. The District Court denied the Board’s motion to dismiss. It assumed, without deciding, that the Board is an arm of the Commonwealth. Thus, as a starting point, the District Court found that the Board was entitled to Eleventh Amendment immunity. At the same time, it concluded that Congress in PROMESA abrogated the Eleventh Amendment immunity, particularly in Section 2126(a)’s jurisdictional provision.

The Court of Appeals for the First Circuit affirmed the District Court’s denial of immunity. Applying First Circuit precedent, the court found that Puerto Rico enjoys sovereign immunity. But the Court of Appeals also held that PROMESA abrogates the Board’s assumed immunity because Congress has made its intention to abrogate this immunity “unmistakably clear” in the language of the statute. In particular, the First Circuit observed that Congress did so in PROMESA Section 2126(a): the “grant of jurisdiction” there “unequivocally stated [Congress’s] intention that the Board could be sued” in federal district court. The court found additional support for its holding in PROMESA Sections 2126(c) and 2126(e). The court reasoned that Section 2126(c) “contemplates” orders of “declaratory and injunctive relief” against the Board. And Section 2126(e), in making certification challenges unreviewable, “implies” that all other claims against the Board likewise come within Section 2126(a)’s scope.

The Supreme Court granted certiorari on the question of whether PROMESA, particularly Section 2126(a), its jurisdictional provision, abrogates the Board’s sovereign immunity. As a threshold matter, the Court assumed, without deciding, that the Board had sovereign immunity, noting that Puerto Rico’s and the Board’s immunity was a settled question of law under circuit precedent. In addition, CPI did not argue that the Commonwealth’s sovereign immunity did not extend to the Board. The Supreme Court addressed only whether, accepting those premises, PROMESA effects an abrogation of that immunity.

The Supreme Court observed that the standard for finding a congressional abrogation of sovereign immunity is a stringent one. It stated that Congress must take its intent to abrogate sovereign immunity “unmistakably clear in the language of the statute.” And “the Court has found that standard met in only two situations. The first is when a statute says in so many words that it is stripping immunity from a sovereign entity.” “The second is when a statute creates a cause of action and authorizes suit against a government on that claim.”

The Supreme Court held that “PROMESA fits neither of those two molds.” First, the Court found that, except in Title III debt restructuring proceedings, the statute does not provide that the Board is subject to suit. The immunity provision that PROMESA borrows from the Bankruptcy Code for Title III cases states that sovereign immunity is abrogated for a governmental unit, including a territory. But, the Supreme Court found, Title III debt restructuring was not an issue here. That is, Congress chose not to adopt similar language to govern other kinds of litigation involving the Board. Second, the Supreme Court reasoned, PROMESA does not create any cause of action that may be asserted against the Board. The majority opinion concluded that nothing in PROMESA makes Congress’s intent to abrogate the Board’s sovereign immunity “unmistakably clear,” and that immunity therefore remained intact.

But the Supreme Court opinion was not unanimous, Justice Clarence Thomas sided with CPI in his dissent. He stated that the Court should have addressed the question of whether Puerto Rico, as a territory, has sovereign immunity. He wrote that “it is difficult to see how the same inherent sovereign immunity that the States enjoy in federal court would apply to Puerto Rico.”

In summary, in its decision, the Supreme Court reversed the lower courts and held that Puerto Rico’s Financial Oversight and Management Board, created by PROMESA, is immune from the kinds of actions brought by the Centro de Periodismo Investigativo to inquire into its work. The Court based its determination on its finding that PROMESA does not expressly authorize the assertion of claims against the Board and, more generally, confirmed that the standard for a statutory abrogation of sovereign immunity under the Eleventh Amendment is a demanding one. This may have consequences for other situations where parties seek to assert claims against entities created by Congress to address particular public policy needs. And Justice Thomas’s dissent may be a harbinger of questions that could be raised about the situation of Puerto Rico in the courts.