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Vol 12, Num 1 l April 2014

Technology and Intellectual Property

► In This Issue:

The Outer Boundaries of a Bankruptcy Court’s Equitable Powers: Equitable Subordination and Equitable Disallowance


by Fouad Kurdi
Georgia State University College of Law

By virtue of loan agreements or a debtor’s acquiescence, a creditor often has varying degrees of influence and control over a debtor and its business. Sometimes, however, a creditor may utilize this control to benefit itself at the expense of other creditors. On the eve of bankruptcy (and even post-petition), such abuse of control is anathema to the delicate distributional scheme guaranteed in the Bankruptcy Code.

The doctrine of equitable subordination, codified in § 510(c)(1) of the Bankruptcy Code, seeks to redress these abuses and protect the integrity of the distributional regime.[1] Additionally, in recent cases, courts have gone a step further, considering the remedy of equitable disallowance whereby a wrongdoer’s claim is not just subordinated, but is disallowed in its entirety.

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The Third Circuit Draws a Line in the Sand on New Value in Friedman’s


by Evan T. Miller
Bayard, P.A.
Wilmington, Del.

Seemingly straightforward on its face, certain aspects of the Bankruptcy Code’s “new value” defense[1] have proven frustratingly unclear for practitioners around the country. Illustrative of this frustration is the elusive answer to perhaps the simplest question: When does it apply? More specifically, if a creditor is paid post-petition for new value that remained unpaid as of the petition date, can that creditor continue to use that same unpaid new value as a defense under § 547(c)(4) of the Bankruptcy Code? The picture remains muddled nationwide, but in the Third Circuit, at least, the answer is now clear.

The Lower Court Split
Courts at both the bankruptcy and district court levels across the country have parted ways on how to answer the foregoing question. In one camp, courts have ruled against cutting the preference analysis off at the petition date, thereby allowing post-petition payments (including, notably, payments on administrative expenses under § 503(b)(9) and payments pursuant to critical-vendor orders) to reduce a defendant’s new value defense.[2] In the other camp, the prevailing view is that the petition date does become the “cutoff” date for assessing new value, such that post-petition payments on pre-petition new value have no bearing on whether a creditor can use that same new value to reduce its liability in a preference action.[3]

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Think Long and Hard Before You Sign Your Client’s Proof of Claim Form


by Jay L. Welford
Jaffe Raitt Heuer & Weiss, P.C.
Southfield, Mich.

Until recently, most attorneys gave little thought as to whether they should be signing proofs of claim in bankruptcy cases on behalf of their clients. If it was more convenient to have an attorney do so, attorneys followed their clients’ wishes and complied. However, based on a recent bankruptcy court decision, it may no longer be preferable to have an attorney sign a proof of claim form on behalf of a client. In an unreported Texas bankruptcy court decision, In re Rodriguez,[1] the court held that the execution of proofs of claim by an attorney constituted a waiver of the attorney client and work product privileges related to the matters set forth in the proofs of claim.

The case began as a hotly contested involuntary proceeding. The petitioning creditors’ proofs of claim sought damages in excess of $70 million and were based on state law tort theories. The claims were objected to and were combined with other matters into an adversary proceeding. The proofs of claim had been signed by the claimants’ attorney. As a result, the debtor deemed the attorney to be a fact witness, and a deposition of the attorney was scheduled. More than 100 different questions were objected to and not answered, based on the assertion by the claimants’ counsel of the attorney client and work product privileges. A motion to compel was thereafter filed, thus framing the issues for the court.

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Third Circuit Holds That Purchaser of Claim Is Subject to § 502(d) of the Bankruptcy Code


by Simon E. Fraser
Cozen O’Connor
Wilmington, Del.


by Benjamin S. Klehr
Cohen Pollock Merlin & Small PC

In recent years, the practice of bankruptcy claims trading has grown dramatically and now represents a multibillion-dollar-per-year marketplace. However, a recent decision by the U.S. Court of Appeals for the Third Circuit may give pause to prospective claim purchasers. In In re KB Toys Inc.,[1] the Third Circuit Court of Appeals held that a claim subject to disallowance under § 502(d) of the Bankruptcy Code in the hands of the original holder is also subject to disallowance in the hands of a purchaser. In other words, a sale does not wash the claim of its susceptibility to disallowance under § 502(d).

Section 502(d) provides:

Notwithstanding subsections (a) and (b) of this section, the court shall disallow any claim of any entity from which property is recoverable under section 542, 543, 550, or 553 of this title or that is a transferee of a transfer avoidable under section 522(f), 522(h), 544, 545, 547, 548, 549, or 724(a) of this title, unless such entity or transferee has paid the amount, or turned over any such property, for which such entity or transferee is liable under section 522(i), 542, 543, 550, or 553 of this title.[2]

The question of a claim’s susceptibility to disallowance under § 502(d) in the hands of a transferee was an issue of first impression in the Third Circuit and, indeed, had never before been addressed by a circuit-level court. The question had previously been addressed in three other published opinions, two from the bankruptcy court for the Southern District of New York, and one from the district court for the Southern District of New York. In a 2003 opinion, the Southern District Bankruptcy Court held that a claim in the hands of a transferee should be disallowed pursuant to § 502(d) where the original claimant had failed to repay liabilities that it owed to the estate under chapter 5 of the Bankruptcy Code.[3] The court next reiterated this holding in a 2007 opinion in the Enron case.[4] However, the District Court for the Southern District of New York subsequently overturned the Enron decision, with a widely criticized holding to the effect that a sale of a claim does transfer the claim free from susceptibility to disallowance under § 502(d), but that an assignment does not transfer the claim free from such susceptibility to disallowance.

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“To Give Is to Live”[1] — But Only Under the Right Circumstances: Nondebtor Plan Releases


by Robert P. Stenzhorn
Schempf & Ware, PLLC
Yorktown, VA

While a number of circuits have held that bankruptcy courts have authority under § 105(a) of the Bankruptcy Code to insulate nondebtors via prospective releases of liability in a confirmed plan, the practice is constrained in other circuits. These minority circuits view the broad powers vested in the bankruptcy court under § 105 as being tempered in application by the specific restrictive language of § 524(e) of the Bankruptcy Code. Because of this appellate split, the ability of a debtor to grant nondebtor releases in a plan is ripe for statutory resolution or an ultimate appeal on the merits to the U.S. Supreme Court.
Section 105(a) enables bankruptcy courts to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”[2] Section 524(e) limits the application of the discharge provisions to debtors, clearly stating that the “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.”[3] Relying in part on § 105(a), a majority of the circuits have permitted nondebtor releases, notwithstanding the language in § 524(e), where the release of such third parties is vital to the debtor’s successful reorganization.

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Join the Committee at ABI's Annual Spring Meeting

The Unsecured Trade Creditors Committee has finalized their plans for the 2014 Annual Spring Meeting! Working with the Legislation Committee, the committee will present the session titled “Municipal Meltdown: Emergency Managers, Receiverships and Other State Law Options for Addressing Municipal Distress.” The conference is back in DC at the JW Marriott, on April 24-27 this year! Check out the full schedule to review the complete list of excellent panels, esteemed speakers and to register.

» Use coupn code ASMSAVE50 at checkout to take $50 off the registration rate!


Chief Bankruptcy Judges Hot Topics Roundtable

Join ABI in person or online for the Chief Bankruptcy Judges Hot Topics Workshop on June 16 at ABI's Conference Center in Alexandria, Va.!

The workshop features Chief Bankruptcy Judges Dennis R. Dow (W.D. Mo.), C. Ray Mullins (N.D. Ga.), Brendan Linehan Shannon (D. Del.), Cecilia G. Morris (S.D.N.Y), and Barbara J. Houser (N.D. Tex.), who will discuss recent circuit splits and hot topics, including the application of the absolute priority rule in individual chapter 11 cases, artificial impairment, structured dismissals, intellectual property licenses, equitable disallowance and § 502(d) issues, and more.

» Register today!

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