chapter 11 structured dismissals: viable exit strategy or...

Chapter 11 Structured Dismissals: Viable Exit

Strategy or Impermissible Under Bankruptcy Code? Evaluating Benefits to Debtors and Creditors, Provisions of

Dismissal Orders, and Key Objections to Structured Dismissals

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TUESDAY, OCTOBER 28, 2014

Presenting a live 90-minute webinar with interactive Q&A

Jay R. Indyke, Partner, Cooley, New York

Michael J. Lichtenstein, Co-Chair Bankruptcy Creditors Rights Group,

Shulman Rogers Gandal Pordy & Ecker, Potomac, Md.

David M. Posner, Member, Otterbourg, New York

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Chapter 11 Structured Dismissals: Viable Exit Strategy or Impermissible

Under Bankruptcy Code?

Evaluating Benefits to Debtors and Creditors, Provisions of Dismissal Orders and Key Objections to Structured Dismissals

Presented by:

October 28, 2014

Jay R. Indyke David M. Posner Michael J. Lichtenstein

• Three primary options for exit vehicles following the liquidation or sale of

substantially all of a debtor’s assets:

• Liquidating Chapter 11 Plan

• Conversion to Chapter 7

• Dismissal of Chapter 11 Case

• Considerations

• Is estate administratively solvent? Can priority claims be paid?

• Can and how will estate professionals be compensated?

• How will settlements with creditors be implemented?

• Are there are remaining assets in the estate?

• Is there a need for a claims resolution process?

• Have claims been paid?

• Finality (i.e., releases, exculpations) for officers, directors and stakeholder groups?

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What is a Structured Dismissal?

• A dismissal with “bells and whistles”

• Involves traditional dismissal of chapter 11 case coupled with some or all of the

following “structured” components:

• Procedures for reconciling and paying claims

• “Gifting” of recoveries to unsecured creditors

• Releases and exculpations

• Provisions for the Bankruptcy Court’s continued retention of jurisdiction over certain post-

dismissal matters

• Conditions to effectiveness of dismissal

• Provisions that, notwithstanding § 349, prior bankruptcy court orders survive dismissal

• Bankruptcy Courts in DE, NY and elsewhere have been approving structured

dismissals with increasing frequency

• However, there are few published decisions that have squarely addressed the issues that

arise in structured dismissals

• Exception: Buffet Partners (discussed herein)

6

What is a Structured Dismissal?

• Three scenarios typically lead to structured dismissals

• Minimal asset sale proceeds leave estate administratively

insolvent or unable to fund a plan process

• Minimal asset sale proceeds (or secured lender settlement)

provide minimal distribution to unsecured creditors; conducting

plan process would eliminate or deplete funds available for

distribution to general unsecured or administrative creditors

• Proponents can demonstrate that reorganization outside

bankruptcy is prudent and likely (even where a plan may

otherwise be feasible)

• Key Factor: demonstrating that there are no assets remaining to

make meaningful distributions to creditors

7

Conditions for Structured Dismissals

• Eliminate cost and delay of plan process

• Eliminate cost, delay, uncertainties and loss of control over causes of action

associated with chapter 7 process and trustee

• Streamline claims resolution process

• May be the difference between administrative solvency and insolvency (i.e.,

if plan process uses remaining funds that would otherwise be used to pay

administrative and priority claims)

• Preserve Bankruptcy Court jurisdiction over matters Bankruptcy Court is

best suited to address

• Effect terms of settlements with creditors without burdensome plan process

8

Benefits of Structured Dismissals

• Liquidating Plan

• Time Consuming – typically 75-90 days from the date of filing the plan to

confirmation thereof

• 28 days’ notice of disclosure statement hearing

• 28 days’ notice of confirmation hearing

• Additional service time

• Expensive

• Drafting fees (plan, disclosure statement, disclosure statement approval

motion, notices, ballots, etc.)

• Service/solicitation costs

• Retention of claims and noticing agent

• Implementation of plan, including paying post-effective date professionals

9

Alternatives to Structured Dismissals in the Liquidation/Post-Sale Context

• Conversion to Chapter 7

• Additional time necessary for chapter 7 trustee to “get up to speed” and fees associated

therewith

• Loss of control over causes of action/preferences

• If causes of action/preferences were not sold to the buyer or otherwise transferred, a chapter 7

trustee may spend time and money investigating and pursuing these claims, even in cases

where a creditors’ committee determined that pursuit of such causes of action was (i) inequitable

to unsecured creditors in cases where unsecured creditors are unlikely to receive a substantial

recovery, (ii) likely to further delay distributions, and (iii) otherwise not a worthwhile use of time

and resources, including delaying distributions.

• Additional layer of fees and expenses associated with (i) possible litigation regarding whether

case should be converted, (ii) subsequent chapter 7 trustee fees and chapter 7 trustee’s

counsel fees, and (iii) payment of U.S. Trustee fees.

• However, conversion to chapter 7 incorporates certain checks and balances that certain

dismissals arguably do not offer (i.e., chapter 7 trustee issues a “final report” identifying assets

liquidated, claims quantified and proposed distributions and chapter 7 trustee is an

independent fiduciary to examine claims and causes of action).

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Alternatives to Structured Dismissals in the Liquidation/Post-Sale Context (cont.)

• “[T]he court shall convert a case under this chapter to a case under chapter 7

or dismiss a case under this chapter, whichever is in the best interests of

creditors and the estate, if the movant establishes cause.” (§ 1112(b))

• Section 1112(b)(4) contains a non-exhaustive list of factors justifying “cause”

• Two most common justifications for structured dismissals:

• “a substantial or continuing loss to or diminution of the estate and the absence of

a reasonable likelihood of rehabilitation” exists (§ 1112(b)(4)(A))

• the debtor is unable to effectuate substantial consummation of a plan (§

1112(b)(4)(M))

• If “cause” is shown, court is required to convert or dismiss case, “absent

unusual circumstances … that the requested conversion or dismissal is not in

the best interest of creditors and the estate.” (§ 1112(b)(1))

11

Legal Bases for Structured Dismissals – § 1112(b)

• The court may dismiss a case under any chapter of the Bankruptcy Code if “the

interests of creditors and the debtor would be better served by such dismissal” (§

305(a)(1))

• § 305 specifically refers to the debtor’s interests, as well as those of the creditors and estate

• Typically relied upon in out-of-court workout scenario (Colonial Ford)

• The remedy is extraordinary, because under§ 305(c), dismissal under § 305 is not

appealable. It requires more than a simple balancing of the harm to the debtor and its

creditors.

• Requires near universal agreement among stakeholders

• Parties requesting structured dismissal under either § 1112(b) and/or § 305(a)(1)

often include a request pursuant to § 105(a) that allows the court to enter orders

necessary or appropriate to carry out the provisions of the Bankruptcy Code

• Parties often assert that the costs of converting to and administering a case under

chapter 7, as well as the enhanced provisions in the structured dismissal order, are in

the best interests of creditors and the estate and is the preferable remedy.

12

Legal Bases for Structured Dismissals – §§ 305(a)(1) and 105(a)

• In a traditional dismissal,§ 349(b) restores all parties’ property rights to

their position prior to bankruptcy

• Typically reinstates receiverships, avoided transfers and avoided liens, revests

property in the debtors, and preserves state law rights

• Court may alter presumptive effects of § 349 for cause

• A structured dismissal order typically will preserve all prior orders of the court

• A common U.S. Trustee objection to structured dismissals is the inherent failure to

reinstate state law remedies

13

Legal Bases for Structured Dismissals – § 349

14

Model Structured Dismissal Order

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Model Structured Dismissal Order (cont.)

In re Buffet Partners, L.P., et al., 2014 WL 3735804,

(Bankr. N.D. Tex. July 28, 2014)

• Case Facts

• Prepetition secured lender purchased substantially all of the debtors’ assets

• Purchaser agreed to assume administrative and priority claims, acquired avoidance

actions and agreed to fund a $500,000 trust for the benefit of general unsecured

creditors. Settlement was approved prior to the filing of the dismissal motion

• Debtors and creditors’ committee jointly sought to dismiss the cases under § 305(a)

• Dismissal motion contemplated dismissal upon certification that (i) committee

completed claims reconciliation process, (ii) all U.S. Trustee fees had been paid, (iii)

general unsecured creditor distributions had been made, and (iv) final fee application

orders were entered

• U.S. Trustee was the sole objector to the dismissal motion

16

Recent Reported Decisions Regarding Structured Dismissals

In re Buffet Partners, L.P. et al.

• Bankruptcy Court’s Opinion – Select Quotes

• “This court begins its look at deals struck in this court with the eye that ‘it’s not my money.’

If appropriate notice is given and the process is fair and does not illegally or unfairly

trample on the rights of parties, the proposal should be approved.”

• “The parties with the skin in the game do not wish to prolong the distribution of funds to

creditors by a conversion to chapter 7, which undoubtedly will do just that. Nor do those

parties want to go through the time and expense of a plan, which will cause the pool of

money left to be greatly diminished.”

• “It is important to emphasize that not one party with an economic stake in the case has

objected to the dismissal in this manner. While this fact is not outcome determinative, it is

still worthy of consideration.”

• “11 U.S.C. §§ 1112(b) and 105(a) provide this court with the requisite authority to

fashion the dismissal order that the parties seek. Although this process is not explicitly

spelled out in § 1112(b), it is clearly within the sphere of authority Congress intended to

grant to bankruptcy courts in the context of dismissing chapter 11 cases.”

17

Recent Reported Decisions Regarding Structured Dismissals (cont.)

In re Felda Plantation, LLC, 2012 WL 1965964 (Bankr. M.D. Fla. May 29, 2012)

• Following debtor’s motion seeking structured dismissal, bankruptcy court granted

the motion and dismissed the chapter 11 case pursuant to an order which included

the following:

• survival of bankruptcy court orders;

• retention of jurisdiction to rule on fee applications;

• payment of U.S. Trustee fees and professional fees; and

• payment of creditors consistent with notice previously provided.

18


In re Fleurantin, 420 Fed. Appx. 194 (3d Cir. 2011)

• After the individual debtor sought an unconditional dismissal of his chapter 7

proceeding, the trustee filed a cross-motion to dismiss with certain conditions

(payment of professional fees and conditions to protect creditors)

• Bankruptcy court granted trustee’s motion; district court affirmed; Third Circuit

agreed that bankruptcy court did not abuse its discretion by dismissing the case

with conditions

• Trustee argued that a structured dismissal with conditions was in the best interests

of the parties, particularly in light of the estate’s continued expenditure of legal

fees in response to the debtor’s motions and other obstructionist efforts

• The Third Circuit noted that the bankruptcy court, which was well aware of those

circumstances, evidently agreed

19


• U.S. Trustees often object to structured dismissals as violations of the Bankruptcy

Code

• Structured dismissals as an end run around chapter 11 plan protections and effect

impermissible sub rosa plans

• Lack requirements for voting, acceptance, disclosure, “fair and equitable” standards,

including the absolute priority rule

• Structured dismissals often distribute estate assets without enforcing Bankruptcy Code

priorities (gifting), addressing all liabilities

• Court approval of gift to junior class may pre-date dismissal

• No legal basis to grant releases and exculpations outside plan process

• Impartial chapter 7 trustee better suited to liquidate estate and distribute proceeds than

potentially conflicted structured dismissal liquidation mechanisms

• Unlike traditional dismissals, structured dismissals fail to reinstate all state law creditor

remedies

• Courts have frequently approved structured dismissals over such objections where all

major creditors support structured dismissal

20

Opposition to Structured Dismissals – Overview

• Opponents argue that structured dismissals are an end run around chapter

11 plan protections

• Lack requirements for voting, acceptance, disclosure

• Relevance of plan solicitation requirements

• Safeguards to ensure that creditors can make an informed decision on

dismissal

• U.S. Trustee has argued that courts might include in sale orders provisions

prohibiting any subsequent structured dismissal

• Is it proper to limit post-sale options in a sale order?

• Can this be reconciled with established dictum that parties can limit sub rosa

plan problems in a 363 sale by not trying to dictate plan treatment in the sale

process?

21

Opposition to Structured Dismissals – Sub Rosa Plan

• Structured dismissals may distribute estate assets without enforcing Bankruptcy Code priorities

• Often a portion of a secured creditor’s collateral or recovery will be gifted to a junior class, typically

unsecured creditors, either before a structured dismissal as part of a case settlement reached between

creditor constituencies or as part of the structured dismissal

• Some may argue that the consideration, claims or causes of action utilized or given to extract the ”gift” is

estate property which cannot be disposed of outside of a plan process

• Structures can be utilized to ensure or enhance the argument that “gift” is not estate property

• A class skipping “gift” may give the U.S. Trustee additional arguments with which to oppose a structured

dismissal as the U.S. Trustee often objects to “gifts” solely in the plan context

• Class skipping is incompatible with “fair and equitable” standards for confirmation of a plan

• May provide for disparate treatment of administrative claimants (estate and committee professionals

versus other administrative creditors)

• U.S. Trustee may assert that the information provided by a disclosure statement is necessary to allow

creditors to assess the adequacy of the amount of the “gift” and whether the consideration provided for

the gift is appropriate

• Should a 9019 or plan standard govern approval of any “gift” included in a structured dismissal?

22

Opposition to Structured Dismissals – Gifting

• Gifting occurs in the context of a plan and outside the context of a plan.

Depending on the context and the jurisdiction, courts have approved and

disapproved “class skipping” gifts

• SPM – the seminal gifting case. The bank and the committee agreed that a portion of

the sale proceeds to the bank would be distributed to the committee subsequent to a

section 363 sale and conversion to chapter 7. The First Circuit held the priority

scheme was not violated because it did not govern rights of creditors as non-estate

property.

• DBSD – A plan that distributed a gift with more value to one class of creditors with

lower priority than a class with higher priority violates the absolute priority rule.

• Armstrong – Distinguished SPM and held that a class skipping gift in a plan violated

the absolute priority rule from which there was no legitimate exception.

• Sharper Image and many others have approved gifts or payments by a secured lender

or non-creditor purchasers of debtor’s assets (World Health, Holly Marine, Fanita

Ranch, Avado Brands).

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Opposition to Structured Dismissals – Gifting (cont.)

• Structured dismissal exculpations often are similar in scope to those found

in plans

• Releases may be more narrowly tailored than might be found in a plan

• UST may assert that structured dismissal forecloses a creditor’s ability to

negotiate releases and obtain improved treatment because the creditor

neither has information provided by a disclosure statement, nor the

leverage of plan voting

• Are the procedural safeguards of a disclosure statement relevant to the Court’s

approval of releases and exculpations?

24

Opposition to Structured Dismissals – Releases & Exculpations

• Claim Reconciliation Issues

• What level of claim reconciliation has been done?

• Methods for determining allowed claims

• Listing of allowed claimholders and amounts in dismissal motion

• Filing of omnibus objection with dismissal motion

• Cost shifting on claim objections

• Who will resolve claim disputes?

25

Opposition to Structured Dismissals – Claim Reconciliation and Distribution Issues

• Distribution Issues

• Mechanism for and timing of distributions

• Who will share in a distribution?

• When will distributions be made?

• Minimum distributions

• Check cashing periods

• Charitable donation of nominal remaining assets

26

Opposition to Structured Dismissals – Claim Reconciliation and Distribution Issues (cont.)

• Structured dismissals often contemplate post-dismissal Bankruptcy Court

retention of jurisdiction for limited purposes

• Final fee applications

• Enforcement of exculpations & releases

• Claims reconciliation

• Bankruptcy courts may be unlikely to retain jurisdiction to resolve claim

disputes

• Structured dismissals fail to reinstate all state law creditor remedies

• Conditions to effectiveness of dismissal

27

Opposition to Structured Dismissals – Retention of Jurisdiction and Other Issues

• In re Buffet Partners, L.P., et al., Case No. 14-30699 (HDH), 2014 WL 3735804

(Bankr. N.D. Tex. July 28, 2014)

• In re AI Liquidation Co., Case No. 13-12874 (CSS) (Bankr. D. Del. 2014)

• In re Felda Plantation, LLC, Case No. 11-14614 (BSS) (Bankr. M.D. Fla. 2012)

• In re Penn Camera Exchange, Inc., Case No. 12-10113 (PM) (Bankr. D. Md. 2012)

• In re Coach Am Group Holdings Corp. et al., Case No. 12-10010 (KG) (Bankr. D. Del.

2012)

• In re Fleurantin, 420 Fed. Appx. 194 (3d Cir. 2011)

• In re Post-Sale Co II, LLC, et al., Case No. 10-13308 (CSS) (Bankr. D. Del. 2011)

• In re Trade Secret, Inc., et al., Case No. 10-12153 (KG) (Bankr. D.Del. 2010)

• In re Alternative Distribution Systems, Inc., et al., Case No. 13099 (PJW)) (Bankr. D.

Del. 2009)

• In re Bag Liquidation, LTD., et al. , Case No. 08-32096 (Bankr. N.D.TX. 2008)

28

Structured Dismissal Precedents

• In re Dawahare’s of Lexington, LLC, Case No. 08-51381 (Bankr. E.D.K.Y. 2008)

• In re KB Toys, Inc., Case No. 08-13269 (KJC) (Bankr. D. Del. 2008)

• In re Foamex International Inc., et al., Case No. 09-10560 (KJC) (Bankr. D. Del.

2009)

• In re G.I. Joe’s Holding Corporation and G.I. Joe’s, Inc., Case No. 09-10713 (KG)

(Bankr. D. Del. 2009)

• In re Shoe Pavilion Inc., Case No. 08-14939 (MT) (Bankr.C.D. CA. 2008)

• In re TSIC, INC., f/k/a Sharper Image Corporation, Case No. 08-10322 (KG) (Bankr.

D. Del. 2008)

• In re Wickes Holdings, LLC, et al., Case No. 08-10212 (KJC) (Bankr. D. Del. 2008)

• In re Harvey Electronics, Inc., Case No. 07-14051 (ALG) (Bankr. S.D.N.Y. 2007)

• In re Princeton Ski Shop Inc., et al., Case No. 07-26206 (MS) (Bankr. D.N.J. 2007)

29

Structured Dismissal Precedents (cont.)

• In re Cornell Trading, Inc., Case No. 06-10017 (JNF) (Bankr. D. Mass. 2006)

• In re Magnolia Energy L.P., Case No. 06-11069 (MFW) (Bankr. D. Del. 2006)

• In re Levitz Home Furnishings, Inc., Case No. 05-45189 (BRL) (Bankr. S.D.N.Y. 2005)

• In re New Weathervane Retail Corporation, et al., Case No. 04-11649 (PJW)

(Bankr. D. Del. 2004)

• In re Blades Board and Skate, LLC, Case No. 03-48818 (NLW) (Bankr. D.N.J. 2003)

• In re Castlton Excavating, Inc., Case No. 03-23649 (Bankr. S.D.N.Y. 2003)

• In re CSI Incorporated, et al., Case No. 01-12923 (REG) (Bankr. S.D.N.Y. 2001)

• In re Shoebilee, Inc., Case No. 01-75781 (Bankr. N.D. Ga. 2001)

• The Sport Shoe, Inc., Case No. 01-64333 (Bankr. N. D. GA. 2001)

• In re Cape May Care Center, Inc., Case No. 00-41945 (NLW) (Bankr. D.N.J. 2000)

• In re Colonial Ford (D. Utah 1982)

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Questions?

Jay R. Indyke

(212) 479-6080

[email protected]

David M. Posner

(212) 905-3682

[email protected]

Michael J. Lichtenstein

(301) 230-5231

[email protected]

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