Bankruptcy Law Insights : Kelley Drye & Warren LLP Bankruptcy and Restructuring Practice Group

The U.S. Supreme Court will rule this term in RadLAX Gateway Hotel Inc. v. Amalgamated Bank on whether the Bankruptcy Code permits a debtor in a chapter 11 case to sell encumbered assets without providing the secured lender an opportunity to credit bid its debt. Determination of this question will require the Court essentially to choose between two opposing approaches to statutory interpretation, and decide whether the so-called “plain meaning” of a highly formalistic reading of the Bankruptcy Code should trump decades of established commercial practice.   

A circuit split arose earlier this year, when the Seventh Circuit in River Road Hotel Partners, a companion case to RadLAX Gateway Hotel, declined to follow the Third Circuit’s 2010 decision in Philadelphia Newspapers, and instead expressly adopted the position set forth in the dissenting opinion from that case of Judge Tom Ambro. As previously described on this site, the debtor in River Road sought to rely on Philadelphia Newspapers in putting forward a plan of reorganization that proposed an auction of the secured lenders’ collateral, but would have expressly denied the lenders the right to credit bid their debt.  Section 1129(b)(2)(A) of the Bankruptcy Code describes three different means by which a plan of reorganization can be found to be “fair and equitable” and thus capable of being confirmed without the consent of a secured lender class (i.e., “crammed down”):

(i) lender retention of liens securing the obligations and receipt of the present value of its secured claim,

(ii) sale of collateral free and clear of liens but subject to credit bidding, or

(iii) the realization by the creditor of the “indubitable equivalent” of its secured claim.

Notwithstanding the express reference in subsection (ii) of Section 1129(b)(2)(A) to the right to credit bid in connection with a sale “free and clear” of liens, the Third Circuit in Philadelphia Newspapers held that a sale “free and clear” could also take place without allowing the lenders to credit bid under subsection (iii), the “indubitable equivalent” prong.  The Third Circuit concluded that the “plain meaning” of the use of the disjunctive “or” in the statute shows that subsection (ii) is not the “exclusive means” by which a secured lender’s collateral may be sold “free and clear” under a plan of reorganization and that, so long as the debtor or other plan proponent could show that the “indubitable equivalent” prong were being satisfied, the opportunity to credit bid need not be provided. 

Judge Ambro, a longtime bankruptcy practitioner before being named to the bench, castigated the majority’s refusal to look beyond what it viewed as the sole plausible reading of Section 1129(b)(2)(A).  In Judge Ambro’s view, the result flew in the face of both the established principle that property rights in bankruptcy look to applicable non-bankruptcy law, and the expectation that the Bankruptcy Code expressly protects such non-bankruptcy rights -- particularly the right of a secured creditor to look to its collateral in the event of non-payment. As he wrote, “In effect, a single ‘or’ becomes the bell, book and candle that excommunicates Congressional intent from the Bankruptcy Code . . . [and] upset[s] three decades of secured creditors’ expectations[.]”

The bankruptcy judge in River Road expressly rejected the reasoning of the Philadelphia Newspapers majority. The Seventh Circuit unanimously agreed, stating that “like the bankruptcy court, we find the statutory analysis articulated by Judge Ambro in his Philadelphia Newspapers dissent to be compelling.” 

The RadLAX Gateway Hotel debtor sought a writ of certiorari from the Supreme Court. They were joined by the Loan Syndication and Trading Association (“LSTA”), a loan market participants’ industry group that has been strongly supportive of lenders’ credit bidding rights. The LSTA announced that it “decided to support the appeal to the Supreme Court because, although [RadLAX Gateway Hotel] is a favorable ruling, the benefit to the market of certainty on credit bidding is an opportunity that cannot be missed.” 

The Supreme Court has not been consistent in its approach to Bankruptcy Code interpretation. While it has strictly applied the “plain meaning” approach in several recent bankruptcy cases, at other times it has been willing to look to underlying Congressional purpose. The latter approach here will unquestionably result in an affirmation of the Seventh Circuit. The former will leave the LSTA regretting that it got what it asked for.

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The U.S. Court of Appeals for the Third Circuit has ruled in Visteon that retiree medical benefits cannot be terminated by a debtor during the pendency of a Chapter 11 case – even if the benefit plan reserved the debtor’s right to terminate such benefits at any time -- unless the debtor complies with the requirements of Section 1114 of the Bankruptcy Code.  In so determining, the Third Circuit, as it did in the recent Philadelphia Newspapers case, has utilized the so-called “plain meaning” mode of statutory interpretation to reach a result that runs contrary to long standing commercial practice and expectations.  The Third Circuit’s obtuse devotion to the “plain meaning” rule is particularly ill-suited to the Bankruptcy Code, a comprehensive statutory scheme deeply rooted in centuries of commercial law.    

Visteon sought, and obtained, approval to terminate its obligations to pay retiree benefits in its Chapter 11 case from the U.S. Bankruptcy Court for the District of Delaware.  Section 1114 limits a debtor’s ability to modify or terminate such benefits, which are defined under Section 1114 of the Bankruptcy Code as payments for medical or related benefits “under any plan, fund or program . . . maintained . . . by the debtor.”  The retirement plans specifically provided Visteon with the right to modify or terminate the plans at any time.  Visteon accordingly argued that it did not need to comply with the procedural steps mandated under Section 1114 which, among other things, require a debtor, before seeking court approval to terminate benefits, to make a modification proposal to “the authorized representative of the retirees”, and “to confer in good faith” with the representative in order to try and reach a settlement.  Visteon asserted that Section 1114 could not provide the retirees with greater substantive rights in the Chapter 11 case than they would have had outside of bankruptcy, a position supported by most courts that have considered the issue.  After the decision was affirmed by the District Court, the retirees’ union appealed to the Third Circuit, which reversed. 

In the Third Circuit’s view, “Section 1114 could hardly be clearer.  It restricts a debtor’s ability to modify any payments to any entity or person under any plan, fund, or program in existence when the debtor files for Chapter 11 . . . .” (emphasis in original).  Congress, it stated, “did not limit § 1114’s otherwise broad scope based on whether or not the debtor reserved a right to terminate in its plan.” 

The problem with the Third Circuit’s approach is that the meaning of Section 1114, as with numerous other provisions of the Bankruptcy Code, is “plain” only if one chooses to read the words in a particular fashion.  An equally natural reading (and thus “plain meaning”) of the statute is to read the words “any payment” as modified by the words “under any plan, fund or program”, thus suggesting that the right to receive such payments is limited by and subject to the express language of such plan, fund or program. 

Logic would suggest that when more than one natural reading of statutory words is evident, a court should look to underlying statutory principles and long standing practice in order to best understand legislative intent.  Indeed, the Supreme Court has long held that contractual and property rights in bankruptcy are defined by reference to applicable state or other non-bankruptcy law.  However, as it did in Philadelphia Newspapers, the Third Circuit refused to recognize any ambiguity whatsoever, notwithstanding the contrary conclusions reached by other courts. (“[T]he reasoning in In re Delphi Corp. is unpersuasive because the court’s analysis is not faithful to the plain language rule that it purports to, and must, apply.”) 

Going forward, in cases in Delaware and other Third Circuit districts, any plausible interpretation of a section of the Bankruptcy Code, regardless of how divorced from established practice and precedent such interpretation may be, can and will be claimed to be “unambiguous”.  The parties asserting such positions will have every incentive not to settle until taking their arguments up on appeal and seeing if they can get a majority of a Third Circuit panel to agree.  Ironically, by furthering the notion that there exists only one true interpretation of broad statutory language, the Third Circuit is achieving precisely the opposite of what it is purporting to do – it is creating uncertainty in the law where none should exist.

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The Third Circuit Court of Appeals issued an en banc opinion (pdf) today in which it overruled the Frenville standard for determining the existence of a "claim" for purposes of Section 101(5) of the Bankruptcy Code. 

The decision, In re Grossman's, Inc., involved a claimant (Van Brunt) whose symptoms did not manifest until years following a Chapter 11 case in which the debtor's plan of reorganization had been confirmed.  It will affect all bankruptcy proceedings in Delaware, and thus will have a very significant impact on how unknown potential tort and environmental claims are resolved in large Chapter 11 cases. 

Under the Frenville "accrual" standard, a "claim" under Section 101(5) was not deemed to exist until a "right to payment" arose under applicable state law.  Because such a right requires a manifestation of symptoms with respect to asbestos exposure, the lower courts had held that Van Brunt's claim did not exist at the time that the Grossman's plan was confirmed and therefore could not have been discharged by the plan.  However, because Frenville has been rejected by nearly every court outside of the Third Circuit, the successor to Grossman's asked the Third Circuit to overrule that standard.  The court, sitting en banc, agreed.  

The Third Circuit noted that some courts have adopted a "conduct" test, in which the prepetition conduct of the claimant, such as the use of a product that gives rise to a later injury, is determinative as to whether a "claim" exists.  Other courts have criticized this approach as too harsh and violative of due process rights, particularly in tort cases, and have required the existence of some level of prepetition relationship, contact, or privity between the debtor and the claimant before a "claim" can arise. 

The Third Circuit appears to be trying to come down in the middle of these two tests, recognizing on the one hand the need to define "claims" in as broad a manner as possible, so as to facilitate the Bankruptcy Code's fresh start policy, and on the other hand the imperatives of fairness and due process.  The court, though determining that Van Brunt had a "claim" that existed at the time of the chapter 11 case, did not opine on whether such "claim" was discharged by Grossman's plan.  It instead remanded the case so that the lower courts could make appropriate findings as to the manner of the bar date notice given during the chapter 11 case and whether, under the circumstances, a discharge of the claim would comport with Van Brunt's due process rights. 

Congress has dealt with this problem in mass tort asbestos cases through Section 524(g), pursuant to which a special trust can be created to deal precisely with the type of unmanifested future claims that arose in Grossman's.  The plan of reorganization in Grossman's, however, did not contain such a trust, so the sufficiency of the due process afforded Van Brunt must be addressed directly.  Whichever way the lower courts rule on this issue, it will in high likelihood come before the Third Circuit again.

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