Delaware Bankruptcy Judge: A Carve-Out for Fees Is Not a Cap

Judge Christopher Sontchi recently issued an important opinion in the Molycorp chapter 11 case.  He held that a standard carve-out in a financing order for the fees of counsel and other professionals for an official creditors’ committee will not later limit the ability of such professionals to be paid in full under a confirmed plan of reorganization.  As with many decisions which come out of the Delaware bankruptcy court, this ruling could have a broad impact on chapter 11 practice in courts across the country.

Molycorp was an unusually large, complex and contentious chapter 11 case, but in a number of respects it was no different than many business reorganization cases which get filed every day. The key one is that it had virtually no unencumbered assets with which to pay the debtor’s professionals and the professionals retained by the official committee of unsecured creditors.  This has become a common situation, particularly in large cases with complicated capital structures which often feature more than one tranche of secured debt.  The only payment source for professionals in these cases is a “carve-out” from proceeds of collateral agreed to by the secured lenders.

Counsel for official committees in chapter 11 cases of this nature take on a challenging role. Official creditors’ committees are tasked with numerous important duties and granted significant powers under the Bankruptcy Code.  In most instances, professionals for the debtor and the secured lenders have been planning the course and timing of the bankruptcy filing and negotiating important pleadings and documents (and the carve-out for the debtor’s professionals) for weeks or even months.  The official committee, however, is not formed and counsel is not engaged until after the case has commenced.  At that point, a tremendous amount of information must be digested and analyzed and there are numerous important motions to address, almost always on an expedited basis.  Counsel must also negotiate the carve-out during this period or else risk non-payment.

Secured lenders consent to carve-outs because they generally prefer chapter 11 cases, where the going concern value of collateral can be preserved and realized through a reorganization or a sale of the debtor’s business, instead of fast liquidations under chapter 7 of the Bankruptcy Code or exercising foreclosure remedies under state law. Official creditors’ committees are a key component of chapter 11 cases.  Even though secured lenders know that committees usually will seek to extract some value from a secured lender for the benefit of unsecured creditors, such as by challenging liens or contesting enterprise valuations, they know also that if there are no unencumbered assets, most bankruptcy judges will require lenders to “pay the freight,” i.e., cover the costs of the chapter 11 cases.

In almost all chapter 11 cases, therefore, secured lenders (grudgingly) agree to a carve-out that will ensure that professionals for a creditors’ committee get paid for at least some of their work. The agreement usually comes only after hard negotiations (typically after sabers have not only been rattled but also drawn), as part of an order that provides new financing and/or permits a debtor to use cash proceeds of collateral in order to operate during the pendency of the bankruptcy case.

The question before Judge Sontchi in Molycorp was whether the carve-out served as a hard cap on fees. Molycorp, following months of hostility between the official creditors’ committee and its secured lender, succeeded in confirming a plan of reorganization.  The secured lender early in the case had consented to a carve-out of no more than $250,000.  In the end, the committee sought payment of nearly $8 million in fees and expenses for its counsel.  The secured lender objected, arguing that the only source of funds were from its collateral, and that because the proceeds of its collateral could not be used without its consent, the fees of the committee’s professionals were capped.

The committee relied on Section 1129(a)(9) of the Bankruptcy Code.  Among the requirements which must be met when a plan of reorganization is confirmed is that all administrative claims (i.e., claims incurred during the bankruptcy case that were necessary for the administration of the debtor’s bankruptcy estate) must be paid in full.  Fees of a creditors’ committee’s professionals are administrative claims.  The committee argued that once Molycorp’s plan was confirmed, Section 1129(a)(9) controlled and that the carve-out in the financing order was no longer operative.

The secured lender responded by noting that Section 1129(a)(9) provides that the holder of an administrative claim may agree to accept less than full payment.  In its view, the carve-out had effectively served as such an agreement.

Judge Sontchi sided with the creditors’ committee. He determined that the carve-out in the financing order could not limit the payment of committee counsel’s fees as administrative expenses under a confirmed plan of reorganization.  The payment of administrative expenses under Section 1129(a)(9), he stated, is “a fundamental statutory requirement of the Bankruptcy Code[.]”

In Judge Sontchi’s view, the carve-out agreed to in Molycorp, which he referred to as “standard”, was only intended to be applicable if Molycorp’s reorganization had failed. If the case had been converted to chapter 7 or dismissed, and the collateral liquidated, the $250,000 would have been the maximum that the committee’s professionals could have received.  But he ruled that the carve-out could not limit payment of committee counsel’s fees pursuant to Section 1129(a)(9).  He acknowledged the secured lender’s argument that a carve-out provision might serve as an agreement to accept less than full payment under a later plan.  However, he determined that the language in the carve-out provision before him “does not contain any language that can compel an automatic disallowance of [committee counsel’s] fees.”  He also signaled, in a footnote that appears to be intended for secured lenders in future cases, that he might not be willing to approve a carve-out provision that were to contain such language.

The first few weeks of representing a creditors’ committee in a large, complex and fast-moving case have been likened by some practitioners as comparable to trying to slow down a freight train by stepping in front it. Judge Sontchi’s analysis, if followed by other courts, will provide committee counsel during these fraught periods with at least a bit more leverage in negotiations with secured lenders over carve-out provisions and payment of fees.

Punt, Pass or Kick? Supreme Court Struggles With Jevic at Oral Argument

The U.S. Supreme Court heard oral arguments this week in the case of Czyzewski v. Jevic Holding Corp.  Although veteran Court watchers caution about seeking to predict ultimate rulings based on justices’ questions and stated concerns, it is difficult to read the hearing transcript and not come away with the view that at least some of the Court’s members are not keen to rule on the merits here.  This would be a relief to many bankruptcy practitioners and commentators who have been concerned about a broad ruling in this case that could significantly limit the ability of parties in bankruptcy cases to craft solutions to difficult issues which do not fit within the strict parameters of the Bankruptcy Code.  A procedural disposition appears possible; alternatively, if a ruling on the merits does get handed down, it is likely to be narrowly crafted.

The complications of Jevic, and the difficult choices facing the Court here, stem from both the knottiness of the specific statutory issues which have been presented, and the complicated process of corporate bankruptcy proceedings in general.  The statutory issues are both broad and narrow: do bankruptcy courts have authority to approve a resolution of a Chapter 11 bankruptcy case in a manner different from the three options specified by the Bankruptcy Code – confirmed plan, conversion to a liquidation under Chapter 7, or dismissal?  Specifically, if the case is to be dismissed, can parties “structure” the dismissal to include substantive provisions regarding the distribution of assets of a debtor’s bankruptcy estate, instead of simply leaving parties to their remedies under applicable non-bankruptcy law?  If yes, then can such provisions effect a distribution of those assets in a manner that contravenes the Bankruptcy Code’s priority scheme?

At the hearing, the justices grappled with whether they were being asked to rule on the broader question of the permissibility of structured dismissals, or the narrower question of adherence to the priority rules.  Justice Kagan specifically pressed the petitioners’ counsel to articulate the holding that they were requesting.  Justice Alito also pushed on this point, and even suggested that the petitioners may have argued a different question than the one on which the Court granted certiorari:

“Something strange seems to have happened between the petition stage and the briefing stage in the case. The question that you asked us to take was whether a bankruptcy court may authorize the distribution of settlement proceeds in a manner that violates the statutory priority scheme . . . And we took the case.  But then the question that you address in your brief refers to ‘structured dismissal.’  There is nothing about structured dismissal in the question that you asked us to take . . . .”

On the merits, several justices did express concern about permitting parties to reach settlements that allocate assets in a manner that diverges from the Bankruptcy Code’s priority rules without the consent of all affected parties.  At the same time, however, at least some of the Court members were aware of the “extraordinary” circumstances presented, and the possible implications of a broad ruling if all deviations from the priority rules were to be prohibited.  Justice Kagan acknowledged that the case could be “one of these extraordinary circumstances in which some people can be better off and nobody will be made worse off.  Still the question is, where is the authorization for that in the Bankruptcy Code?”  Chief Justice Roberts observed to respondents’ counsel that “the reasonableness of your position is directly related to how extraordinary the extraordinary circumstances have to be.”

The ambivalence may suggest that some of the justices prefer to avoid a ruling on the merits and are looking for another path. As Justice Alito noted, a clear conflict between circuits exists on the permissibility of asset distributions at variance with the Bankruptcy Code’s priority scheme, but not on the issue of structured dismissals.  His statement above about the possible change in the framing of the question presented could be a prelude to a procedural disposition of the case, such as a dismissal of the appeal based upon an improvident granting of certiorari.  In any event, even with a ruling on the merits it appears less likely that Jevic will be the seminal case that some have feared.

Jevic Could Be the Most Consequential Chapter 11 Decision in Many Years

The U.S. Supreme Court will hear the case of Czyzewski v. Jevic Holding Corp. during the new term that began last week.  The questions it presents are relatively simple.  First, can a bankruptcy court, in dismissing a case under the U.S. Bankruptcy Code, permit parties to “structure” the dismissal to include substantive provisions regarding the distribution of assets of a debtor’s bankruptcy estate, instead of simply dismissing the case and leaving parties to their remedies under applicable non-bankruptcy law?  If yes, then can such provisions effect a distribution of those assets in a manner that contravenes the Bankruptcy Code’s priority scheme?  Most observers anticipate that the Court will focus on solely on the second question, and issue a fairly narrow ruling.  A ruling on the first question, however, would be far broader and could have as significant an impact on Chapter 11 bankruptcy practice as any case that the Court has decided in decades.

The facts of Czyzewski are straight-forward.  Jevic was a New Jersey trucking company; it filed for bankruptcy under Chapter 11 of the Bankruptcy Code following a failed leveraged buyout.  Jevic never attempted to reorganize; it ceased operations immediately prior to its bankruptcy filing and terminated nearly all of its driver employees.  Its secured lender, CIT Group, held a lien on virtually all of its assets, which were worth far less than the amount owed on the loan.  The drivers filed WARN Act claims for unpaid wages against Jevic and Sun Capital, its private equity sponsor.  Sun also held a portion of the secured debt.  An official committee of unsecured creditors was appointed, which commenced fraudulent conveyance and equitable subordination litigation against CIT and Sun.

Three years later, the case was in a place that has become all too familiar to Chapter 11 practitioners. All of the assets had been sold off and the proceeds distributed to the secured lenders.  Nothing remained of the Jevic bankruptcy estate except $1.7 million in cash (which was subject to the secured lenders’ lien) and the litigation claims against CIT and Sun.  The case was effectively at an impasse.  A plan could not be confirmed, because there were insufficient funds to pay all of the expenses of administration of the Chapter 11 case, such as the fees of professionals for Jevic and the creditors’ committee.  The only other means specified by the Bankruptcy Code of resolving a Chapter 11 case are either a conversion to a liquidation under Chapter 7, or a dismissal of the case under Section 349 of the Bankruptcy Code.  Under either of those approaches, however, professional fees would not have been paid, and no recovery would have been received by any creditors other than CIT or Sun.

Another path was taken. The case was dismissed, but the dismissal was structured in such a way so as to incorporate a settlement among Jevic, CIT, Sun, and the creditors’ committee.  Such “structured dismissals” have become increasingly common over the past several years.  As a proliferation of secured financing has resulted in more cases lacking sufficient unencumbered assets to finance an exit from Chapter 11 through plans of reorganization or liquidation, structured dismissals have been utilized by creative practitioners to wind down what would otherwise be irresolvable morasses.  Under the Jevic structured dismissal, CIT and Sun agreed, in exchange for a release of the litigation, to allow the $1.7 million in cash plus another $2 million they contributed to be used to pay administrative expenses and to provide a small distribution for general unsecured creditors.

The drivers, however, were not part of the settlement, because they refused to release their WARN Act litigation against Sun. They therefore received nothing, even though their claims for unpaid wages against the Jevic bankruptcy estate were entitled to priority treatment ahead of general unsecured claims.  The bankruptcy court nevertheless approved the settlement and the structured dismissal, finding that there otherwise was “no realistic prospect” of a recovery to any parties but CIT and Sun.  The U.S. Court of Appeals for the Third Circuit affirmed.

The Supreme Court granted certiorari on the question of whether a structured dismissal in a chapter 11 case can incorporate a settlement that diverges from the Bankruptcy Code’s priority scheme. It is possible, however, that the Court may first look at the broader issue of whether a dismissal that is “structured” is even a permissible means of resolving a chapter 11 case.

These issues could lead the Court to resolve a basic question that has driven arguments on the Bankruptcy Code for decades. It’s a debate between lawyers and judges who take a pragmatic view of the Bankruptcy Code, versus those who adhere strongly to the “plain meaning” rule of statutory interpretation.  The first group believes that the Bankruptcy Code was intentionally designed by Congress to be as flexible as possible and, while unstated, also was intended to be built upon and carry forward any number of long-standing practices derived from decades, and in some instances centuries, of commercial law.  In this view, the Bankruptcy Code was specifically intended to allow parties to develop solutions to difficult issues which do not fit within the strict parameters of the statute.

Jurists and practitioners on the other side contend that bankruptcy judges must defer to the plain meaning of the Bankruptcy Code and are not at liberty to approve solutions to problematic situations, such as a structured dismissal for resolving a log-jammed chapter 11 case, which go beyond those specifically provided by Congress. In Czyzewski, the drivers contend that because there is no express authority for structured dismissals under the Bankruptcy Code, the proposed deal among the other parties must fail.  The Third Circuit acknowledged the lack of statutory authority; however, it affirmed the lower court decisions as the “least bad alternative”, and ruled that a dismissal under Section 349 of the Bankruptcy Code could be accompanied by other court orders giving effect to a settlement, providing releases, and disposing of loose ends which otherwise would require continued litigation in another forum.

The second issue delves even deeper into the heart of the Bankruptcy Code. The “absolute priority rule” means that in a plan of reorganization, creditors with claims which would be entitled to seniority in the event of a straight liquidation must get paid ahead of creditors whose claims would be junior in priority.  The Third Circuit was troubled by the fact that general unsecured creditors would receive some small payment while the drivers with higher priority claims would be paid nothing.  The Court nevertheless upheld the settlement.  It determined that under a settlement, parties could deviate from the Bankruptcy Code’s priority scheme if “specific and credible grounds” so justified.  The dispositive factor in this instance was that under the only realistic alternative, no parties other than CIT and Sun would have received anything.  Although the Jevic bankruptcy estate held litigation claims, there were no assets to fund them.  Under any viable scenario, the drivers were receiving $0.  The only real question was whether such non-payment should obviate the possibility of any other party receiving any funds.  The Third Circuit declined to find “that our national bankruptcy policy is quite so nihilistic[.]”

The Court, as demonstrated by its recent decision in Baker Botts v. Asarco, leans strongly toward the plain meaning rule of statutory interpretation in bankruptcy cases, which suggests that the Court will reverse the Third Circuit here.  The main suspense in the outcome of Czyzewski lies not in the outcome per se, but rather in whether the Court rules broadly or narrowly.  A narrow ruling addressing only the second question here, overturning the ruling below based on the proposed recovery to general unsecured creditors ahead of the drivers and their claims for unpaid wages, would be significant but not too remarkable.  The Court could go further, however, and altogether invalidate structured dismissals due to the lack of specific authority.  Such a ruling could markedly alter the chapter 11 landscape.  The Supreme Court, however, has evidenced little concern in recent times for the extent to which its rulings in bankruptcy cases conflict with established practices, such as when it invalidated a long-standing jurisdictional scheme a few years ago in Stern v. Marshall.

One of the hallmarks of Chapter 11 has been the consistent ability of practitioners and judges to adapt it to situations that lie well outside of the intentions of the drafters of the Bankruptcy Code, such as in asbestos and other mass tort cases, or mega-cases such as the GM and Chrysler bankruptcies, and which likely would otherwise defy resolution. For better or worse, a broad ruling by the Court in Czyzewski would limit creative uses of the Bankruptcy Code, and substantially affect the manner in which difficult Chapter 11 cases are approached and resolved.

Secured Creditors Can Chill a Bit Following Aeropostale Ruling

The ability of a secured creditor to credit bid its debt in connection with a sale of a debtor’s assets received a strong boost in a decision last month in the Chapter 11 case of Aeropostale from U.S. Bankruptcy Judge Sean Lane of the Southern District of New York.  Two recent decisions, Fisker Automotive and Free Lance-Star Publishing Co., had surprised many observers by narrowing the rights of secured creditors to credit bid, and resurrected uncertainty about a debtor’s ability to limit those rights (a dispute that had appeared to have been resolved in favor of secured creditors only a few years earlier by the Supreme Court’s decision in RadLax Gateway Hotel).  In particular, Fisker Automotive and Free Lance-Star Publishing Co. suggested that the potential of a credit bid to “chill” bidding by other prospective buyers could suffice to limit a secured creditor’s rights.  Judge Lane’s ruling in Aeropostale significantly walks back those decisions and narrows the grounds on which credit bidding rights can curtailed.  (Kelley Drye & Warren LLP represents parties in the Aeropostale case but took no part in the matters discussed here.)

Section 363(k) of the Bankruptcy Code provides that secured creditors may credit bid the full amount of their debt when their collateral is sold, “unless the court for cause orders otherwise . . . .” (emphasis added).  Credit bidding in bankruptcy protects the expectations of secured creditors under non-bankruptcy law to be able to look to their collateral in the event of a default.  The Bankruptcy Code does not define what constitutes “cause”, but for many years it was generally viewed as being narrow in scope, such as a creditor’s bad faith or misconduct.  A controversy arose a few years ago when the U.S. Court of Appeals for the Third Circuit unexpectedly limited a secured creditor’s right to credit bid in the absence of “cause” in the Philadelphia Newspapers case.  That decision was effectively overruled by the Supreme Court’s decision in RadLax.

Fisker Automotive and Free Lance-Star Publishing Co. put the issue of credit bidding back on the table, creating controversy over how broadly courts could define the meaning of “cause” under Section 363(k).  Specifically, although there was evidence in each case of inequitable creditor conduct and possible invalidity of security interests, both rulings suggested that “cause” could be based solely on the goal of fostering a competitive auction process, i.e., not “chilling” the bidding.  This aspect of the rulings in Fisker Automotive and Free Lance-Star Publishing Co. raised particular concern for secured creditors.  Credit bidding can nearly always be said to “chill” competing offers.  In one sense, that is its very purpose – to protect a secured creditor from being forced to accept a cash payment that is below the value the secured creditor believes the collateral possesses.

In Aeropostale, the debtors engaged in a sale of substantially all of their assets, and sought to limit the ability of its secured lenders to credit bid.  The lenders are affiliates of a private equity firm, Sycamore Partners, that through other affiliates also owned equity in in Aeropostale and held a controlling interest in one of its largest suppliers.  The debtors alleged a broad range of inequitable conduct against Sycamore Partners and its affiliates arising from the multi-faceted connections, in an effort to show that the “cause” standard under Section 363(k) was satisfied.  Relying on Fisker Automotive and Free Lance-Star Publishing Co., the debtors also contended that permitting the secured lenders to credit bid would deter other parties from putting forward offers and would “chill” the bidding.

Following a multi-day trial, Judge Lane rejected the allegations regarding inequitable conduct on the part of Sycamore Partners and its affiliates, finding that each of the Sycamore related entities had acted in accordance with its contractual rights and had taken reasonable steps to protect its financial interests.  This left the question of whether “cause” could be shown merely by the possible negative effect on the sale process of permitting the secured lenders to credit bid.

Judge Lane expressly declined to give Fisker Automotive and Free Lance-Star Publishing Co. the expansive readings requested by the debtors.  He acknowledged that “courts will sometimes refer to concerns about the chilling of bidding as a factor [in considering whether to limit the ability to credit bid].”  However, he observed that the court in each those cases found both evidence of inequitable conduct on the part of the secured creditor, and questions regarding the extent and validity of the security interests held.  In contrast, Judge Lane found no bad actions on the part of the Sycamore partners and its affiliates in Aeropostale.  He also noted that no party had challenged the extent and validity of the secured lenders’ liens and security interests.  Judge Lane made clear that absent those factors, “cause” could not be shown.  “[T]he Court is unaware of any cases where the chilling of bidding alone is sufficient to justify a limit on a credit bid.” (emphasis added).

He also referenced the recent comprehensive report published by the American Bankruptcy Institute Commission to Study the Reform of Chapter 11.  The report has been criticized by banking groups and associations for certain recommendations which have been viewed as contrary to the interests of secured creditors.  With respect to credit bidding, however, the report came down firmly on the side of such interests.  Judge Lane cited its finding regarding “the fundamental role of credit bidding under state law and section 363(k)”, and conclusion that “the chilling effect of credit bidding alone should [not] suffice as cause under section 363(k).”

Judge Lane’s comprehensive Aeropostale opinion squarely addresses the key question that arose from Fisker Automotive and Free Lance-Star Publishing Co.  If followed by other courts, it will resolve that credit bidding rights may not be limited “for cause” where a secured creditor exercises its rights in good faith, and in the absence of any malfeasance or issues regarding the extent or validity of liens.  Even if doing so would enhance the prospects of a competitive auction for a debtor’s assets, Aeropostale makes clear that limitations on credit bids should not be permitted.

Energy Future Holdings Chapter 11 Case – The Largest Game Ever of Texas Hold’em?

The chapter 11 case of Energy Future Holdings (“EFH” or “Debtors”) roared back to life this month. Certain key conditions for the plan of reorganization approved last December (the “First Plan”) to become effective were not met by a deadline of April 30, and one of the major parties to the support agreement that underlay the First Plan gave written notice of termination on May 1.  The Debtors followed up immediately by filing a new proposed plan and a motion seeking a confirmation hearing in early August.  (Kelley Drye & Warren LLP represents a creditor of certain Debtors, but has taken no part in the matters discussed here).

EFH entered bankruptcy in April 2014 with over $42 billion in claims, and for well over a year it looked to be among the most intractable cases ever filed. The Debtors’ business operations are divided into two distinct silos: a majority interest in a regulated electrical utility, Oncor, indirectly owned by EFH subsidiary Energy Future Intermediate Holding Company LLC (the so-called “E side” of EFH), and non-regulated electricity generation, mining, and commodity risk management and trading operations, indirectly owned by EFH subsidiary Texas Competitive Holdings Company LLC (the so-called “T side” of EFH).

At the outset, EFH had the support of its E side creditors, who stood to see a substantial recovery from a proposed sale of the Oncor interests, but was facing intense opposition from junior creditors on the T side, who appeared to be out of the money. In the summer of 2015, however, the T side creditors began to coalesce around a bold strategy to backstop a real estate investment trust (“REIT”) structure to take control of the Oncor assets.  A REIT is a hybrid tax entity that is able to reduce or eliminate substantially all of the entity-level federal income taxes otherwise imposed on corporations by distributing its taxable income to shareholders.  The junior T side creditors, who had been prepared to prosecute a campaign of scorched earth litigation against the Debtors, their private equity sponsors and the senior T side creditors, began instead to negotiate the terms under which they would agree to backstop the new REIT vehicle.

The junior T side creditors proposed to pair with Hunt Group, a long time Texas utility operator. When it became clear that a plan of reorganization based on the transfer of the Oncor assets to a REIT structure could (i) garner support from all levels of the T side capital structure, and (ii) generate sufficient value to pay all E side creditors in full, EFH agreed to move forward with it.  Under the First Plan, the Hunt Group committed to provide over $7 billion, and the junior T side creditors agreed to backstop a $5.2 billion rights offering.

The riskiness of the First Plan was acknowledged by all parties. It would require numerous state and federal approvals, including from the IRS and the Texas Public Utility Commission (the “PUC”).  As the quid pro quo for agreeing to pursue the REIT structure, the Debtors insisted that the junior T side creditors agree to a global settlement that would be binding regardless of whether the First Plan ever became effective.  If the REIT proposal failed to garner the necessary approvals, the global settlement was intended to allow the Debtors to focus on an alternative path to exit the chapter 11 cases.  The junior T side creditors agreed to waive any claims against the Debtors, their private equity sponsors and the senior T side creditors, and to accept under an alternative plan a payout of $550 million, a small fraction of their claims.

The PUC approved the deal in March, but with a crucial caveat. Responding to objections raised by municipalities and consumer groups, the PUC issued an approval order that expressly left open the possibility that the Oncor investors (i.e., the junior T side creditors) might not be given the full tax benefits of the REIT structure, but instead might have to share such benefits with ratepayers.  The Oncor investors refused to close the deal on that basis.

Under the First Plan and the related agreements, the Oncor investors were required to close by April 30. However, that date was subject to an extension to June 30 if the PUC approval order had been approved.  The Oncor investors and the Hunt Group evidently believed that they had the additional time, and had already requested a new hearing before the PUC.  The Debtors and the senior T side creditors took the position that the PUC’s order was insufficient, since it did not resolve the treatment of the REIT tax benefits.  The Oncor investors could have effectively bought additional time by agreeing to give up $50 million of the their alternative payout consideration of $550 million, but they declined.  The T side senior creditors sent a notice of termination of the plan support agreement, thus effectively rendering the First Plan “null and void”.

Where the case proceeds from here is anyone’s guess. The machinations of the past several weeks could all be an elaborately choreographed series of steps to place maximum pressure on both the PUC and the Oncor investors to reach a resolution that would lead the Oncor investors to proceed forward.  The Debtors could withdraw the proposed new plan and seek to revive the First Plan.  The Debtors’ new plan also leaves open the possibility of a new REIT structure deal.  It also leaves open virtually any other possible exit strategy, such as a new auction process for Oncor.  At least one earlier bidder for the Oncor assets, NextEra Energy, has already made clear its continued interest.

Confirming a new plan for the T side Debtors should be fairly straight forward at this point, given the agreement by the T side junior creditors to settle their litigation claims and accept $550 million. Formulating a confirmable plan for the E side Debtors without the substantial value created by the REIT transaction could be long and difficult.  At a hearing last week, Judge Christopher Sontchi effectively split up the cases.  Confirmation of a new plan for the T side Debtors is scheduled to take place in August.  Judge Sontchi tentatively scheduled a confirmation hearing for the E side Debtors to begin in late September, but he acknowledged that with so many unresolved issues, that timing is unlikely to hold.

Heightening the intrigue, as Judge Sontchi noted last week, is the fact that the 18 month period in which the Debtors had the exclusive right to propose a plan of reorganization has expired.  This means that any party now has the ability to put forward a plan for reorganizing or selling the E side Debtors’ interests in the Oncor assets.  NextEra Energy is strongly believed to be considering such a strategy.

Any exit path for the E side Debtors will likely take a minimum of several months. Several sophisticated parties with billions of dollars at stake are sitting around a table, each waiting to see who will reveal their hole cards first.

Landlords Beware: Lease Terminations May Be Voidable In Bankruptcy

The Seventh Circuit Court of Appeals recently handed down a decision with significant implications for landlords contemplating lease termination agreements with distressed tenants. Ruling on a direct appeal in the chapter 11 case In re Great Lakes Quick Lube LP, the court held that a lease termination agreement between a landlord and a financially distressed tenant can be voided as either a fraudulent conveyance or a preferential transfer in the tenant’s subsequent bankruptcy case.

The debtor-tenant owned and operated a chain of automotive maintenance stores in the Midwest.  Less than two months before its chapter 11 filing, the debtor agreed with one of its landlords to terminate leases at five locations; two were profitable and three were not.  After the bankruptcy filing, an official committee of unsecured creditors was formed and eventually granted standing to pursue an action against the landlord on behalf of the debtor-tenant’s bankruptcy estate to recover the alleged value of the leases for the two profitable locations.

The bankruptcy court ruled that the lease terminations were not “transfers” for purposes of the avoidance statutes and that, even if a transfer had occurred, they could not be avoided and recovered by the estate because Section 365(c)(3) of the Bankruptcy Code prevents the assumption or assignment of a lease that has been validly terminated prior to the bankruptcy filing. The bankruptcy court also found that the debtor’s estate had received a benefit from being relieved of the lease payments at the three unprofitable locations

The Seventh Circuit reversed. The court determined that a “transfer” did occur when the debtor’s rights under the lease were terminated, and disagreed with the bankruptcy court’s finding regarding the non-avoidability of the value of such transfer.  Judge Richard Posner, writing for the court, disregarded the effect of Section 365(c)(3) of the Bankruptcy Code because the creditors’ committee was only trying to recover the value of the leaseholds, and not the leaseholds themselves.  Judge Posner also focused solely on the potential value lost by the debtor’s bankruptcy estate from the leases for the two profitable locations, and remanded the case back to the bankruptcy court to determine such value.  The bankruptcy court’s finding regarding value from the release of lease obligations at the three unprofitable locations did not insulate the transactions from further scrutiny regarding the possible value lost by the debtor’s estate from the termination of the profitable leases.

This is an important decision for landlords, as it stands as an invitation to trustees and creditors’ committees at a minimum to investigate, and possibly commence similar actions, where leases have been validly terminated pre-petition.  Although the opinion is very short and scant in its reasoning, Judge Posner is a highly regarded jurist and for that reason alone the decision is likely to draw the attention of other judges.  Landlords contemplating terminating leases with distressed tenants, particularly in the Seventh Circuit states of Illinois, Wisconsin and Indiana, will need to focus closely on the potential value of any leasehold interests being recovered and any benefits such tenants will be realizing in connection with the release from obligations under such leases.

Ruling on Pipeline Agreements in Sabine Chapter 11 Case Indicates Battles That Lie Ahead in Energy Company Bankruptcy Cases

U.S. Bankruptcy Judge Shelley Chapman ruled last week in the chapter 11 case of Sabine Oil & Gas that Sabine could utilize the U.S. Bankruptcy Code to “reject” certain agreements with pipeline operators.  This decision will permit Sabine to walk away from its obligations under the agreements and leave the pipeline operators with nothing but a claim in the bankruptcy case for breach of contract damages (a claim that is likely to be virtually worthless).  It upends the generally held view regarding the nature of these types of agreements, which is that they create cognizable real property interests under applicable state law.  Such real property interests have far stronger protections in bankruptcy cases than contractual rights.

Sabine, an exploration and production (E&P) company, filed for bankruptcy under chapter 11 of the Bankruptcy Code back in July 2015 in the Southern District of New York. Similar to most E&P companies, it had arrangements with two midstream gathering and processing (G&P) companies that gathered, treated, transported and processed Sabine’s oil and gas productions.  As is typical with these arrangements (the “midstream agreements”), Sabine agreed to dedicate certain oil and gas production to the G&P companies, and they, in turn, committed at their own expense to construct, operate and maintain for Sabine a system of pipelines and facilities.  Sabine committed under the midstream agreements to deliver certain minimum amounts of oil and gas on an annual basis, or else to make deficiency payments and other fees over a term of ten years.  The midstream agreements specifically provided that they are covenants intended to “run with the land.”

After filing for bankruptcy, Sabine sought to reject the midstream agreements. Section 365 of the Bankruptcy Code permits debtors to walk away from unexpired contracts and leases if they can demonstrate that such agreements are burdensome to their bankruptcy estates and that doing so would be in the best interests of the debtor and all of its creditors.  This is a crucial power under the Bankruptcy Code for troubled companies that are seeking to reorganize.

The G&P companies objected, and asserted strongly that the rejection of the midstream agreements would be of little avail to Sabine, because Sabine had conveyed real property interests to the G&P. They contended that even if Sabine terminated its ongoing contractual obligations under the midstream agreements, the covenants that run with the land could not be affected.

Property rights in bankruptcy are determined by applicable non-bankruptcy (in this case Texas) law. Notwithstanding that the covenants in the midstream agreements purported to run with the land, Judge Chapman, lamenting the “arcane and anachronistic rules” governing real property covenants, observed that the parties’ intentions were not necessarily dispositive, and that a number of conditions were required to be met in order to establish the existence of real property rights in Texas.  Since there were no decisions on point by the Texas Supreme Court that controlled all aspects of the questions at issue, she undertook her own analysis of whether the covenants between Sabine and the G&P companies did in fact “run with the land.”  She concluded that no such real property rights were created under Texas law.  (For technical reasons under the Federal Rules of Bankruptcy Procedure, she did not make a “final” ruling, but instead provided a “non-binding analysis” that can be readily applied when the procedural deficiencies are remedied).

Under Judge Chapman’s reading of Texas law, for a covenant to run with the land and thereby create a real property interest, among other things it must “touch and concern” the land (i.e., affect the fee owner’s ownership rights in some way), and also result from a “horizontal privity” between the parties (i.e., result from some transactional relationship between the parties, such as the reservation of certain rights upon a conveyance of a tract of land). In Judge Chapman’s view, the midstream agreements did not satisfy either of those requirements.  Instead, she found that

[Sabine] simply engaged [the G&P companies] to perform certain services related to the hydrocarbon products produced by Sabine from its property. The covenants at issue are properly viewed as identifying and delineating the contractual rights and obligations with respect to the services to be provided, and not as reserving an interest in the subject real property.

The decision in Sabine clearly has significant potential ramifications for G&P companies which have made substantial investments in facilities and infrastructure for distressed E&P companies. If Judge Chapman’s analysis is followed by other courts, E&P companies in chapter 11 would have the ability effectively to wipe out those investments by rejecting the midstream agreements under Section 365 of the Bankruptcy Code.  Other aspects of the Bankruptcy Code are implicated as well.  For example, a debtor in bankruptcy may sell its assets under Section 363 of the Bankruptcy Code “free and clear” of most contractual rights.  It is far more difficult to strip away real property interests such as covenants that run with the land.  This precise issue has arisen in the chapter 11 proceedings of Quicksilver Resources, which is pending in the District of Delaware, and a decision in that case from U.S. Bankruptcy Judge Laurie Silverstein is expected very shortly.

A number of factors make clear, however, that Judge Chapman’s decision will not, in and of itself, lead to a cascade of E&P companies seeking to reject midstream agreements with G&P companies. First and foremost, as the opinion itself demonstrates, the resolution of these questions is highly dependent on the facts of each individual case.  For example, Judge Chapman noted that Sabine only granted rights to the G&P companies in hydrocarbons after they were extracted from the ground and were thus personal property under Texas law.  Had the G&P companies in Sabine been granted rights to minerals in the ground, they would have constituted an interest in real property, and the outcome could very well have been different under Judge Chapman’s analysis.

Next, while Judge Chapman’s opinion will undoubtedly be persuasive, it will not be binding on any other court, even in the Southern District of New York. Judge Silverstein will shortly be rendering her decision in Quicksilver, and bankruptcy courts in Texas will almost certainly soon be weighing in on this topic.  Some of these decisions are certain to be appealed, setting up a process that will take two or three years, at a minimum, to play out in full.  Ultimately, it is not unreasonable to expect that a federal court of appeals will certify this question to the Texas Supreme Court for resolution.  The laws of different states are certain to be implicated in other cases as well.

Many industry observers are justifiably concerned over the prospects of G&P companies in the wake of the severe economic distress facing E&P companies, and whether other troubled E&P enterprises will similarly seek to jettison pipeline arrangements and other types of midstream agreements in bankruptcy.  However, Judge Chapman’s opinion will not in and of itself be a game-changer regarding the rights of G&P companies.  It is, rather, the first salvo in what could be a protracted battle among E&P companies and G&P transporters, and ultimately probably downstream refiners as well (and their accompanying lenders, creditors and investors) regarding the allocation of the ongoing economic pain stemming from historically low prices for oil and gas.  Many similar encounters lie ahead.

Delaware Bankruptcy Judge Rejects Effort to Circumvent Supreme Court’s Asarco Decision

The Supreme Court’s decision last term in Baker Botts v. Asarco, in which the Court ruled that professionals that are paid from a debtor’s bankruptcy estate cannot be compensated for time spent defending their fee applications, continues to rankle bankruptcy practitioners.  Moreover, a recent decision in a Delaware bankruptcy case shows that the impact of Asarco will not be easily circumvented.

Attorneys and other advisors retained by a debtor, a trustee or an official creditors’ committee are known as “estate professionals,” because their retention in each case must be approved by the bankruptcy court, and their fees and expenses are paid out of the debtor’s bankruptcy estate and are subject to review and approval pursuant to Section 330 of the Bankruptcy Code.  Section 330(a)(1) of the Bankruptcy Code states, “After notice to the parties in interest and . . . a hearing . . . the court may award to . . . a professional person . . . reasonable compensation for actual, necessary services . . . .”

In Asarco, the law firm of Baker Botts was retained to represent the debtor in its chapter 11 bankruptcy case. During the case, Baker Botts sued Asarco’s parent company to recover improperly transferred assets, and won a huge recovery for the benefit of Asarco’s creditors. At the end of the chapter 11 case Baker Botts applied to the bankruptcy court for final approval of $120 million in fees and expenses, plus a performance bonus of $4.1 million.  Asarco, which wound up back under the control of its parent company after all of its creditors were paid in full, objected to Baker Botts’ fee application.  Following a multi-day trial, the bankruptcy court approved Baker Botts’ requested fees and also awarded it over $5 million to cover the costs incurred in defense of those fees. The Fifth Circuit reversed the award of fees for defending fees, and the Supreme Court upheld that reversal.

The Court’s analysis was straight-forward: under American jurisprudence, each side in a litigated dispute bears its own attorneys’ fees, unless there is an applicable statute or agreement that provides otherwise.  In the Court’s view, the plain text of Section 330(a) does not support a deviation from the “American Rule” regarding attorneys’ fees.  Citing to Webster’s New International Dictionary, the Court’s majority stated, “The word ‘services’ ordinarily refers to ‘labor performed for another.’”  Since Baker Botts was litigating to defend its own fees, the Court reasoned, it was not providing an “actual, necessary service” to the bankruptcy estate and therefore was not entitle to compensation for such time.

As many commentators have noted, the implications of Asarco in chapter 11 cases going forward could be substantial.  The requirement of bankruptcy court approval for all fees paid to estate professionals helps to maintain the fairness and integrity of the bankruptcy process, and is accepted as an inconvenient but necessary requirement by law firms and other professional firms that undertake such work.  That fees may only be allowed after a “hearing” necessarily implicates a contested process, and challenges from other parties have always been a recognized hazard for such firms.  A prohibition on compensation for costs incurred in fee disputes places estate professionals at a clear disadvantage.

Two weeks ago, Judge Mary Walrath, a well-regarded jurist in the influential Delaware bankruptcy court, denied an effort in the Boomerang Tube chapter 11 case to work around Asarco contractually.  Judge Walrath, in a carefully considered decision, makes her view clear that Asarco imposes a broad prohibition on fee-shifting into the Bankruptcy Code, one that estate professionals may not sidestep by contract.

Boomerang Tube filed for bankruptcy under chapter 11 last June. A short time thereafter, and right after the Asarco decision was handed down, the U.S. Trustee for the District of Delaware (a representative of the U.S. Department of Justice) appointed an official committee of unsecured creditors (the “Committee”), and the Committee selected Brown Rudnick LLP to represent it.

Brown Rudnick’s effort to render Asarco inapplicable to its applications for payment in Boomerang Tube was straight-forward.  In its motion to Judge Walrath to be approved as Committee counsel, the firm asked for the approval order to include a provision that would entitle it to be compensated from Boomerang Tube’s bankruptcy estate for any fees, costs or expenses incurred in defending its fees against any challenges.  In support of this provision, Brown Rudnick contended that Section 328 of the Bankruptcy Code allows for the retention of estate professionals “on any reasonable terms and conditions.” It further argued that Asarco had ruled only that Section 330 did not create an exception to the American Rule against fee shifting, and that the Supreme Court had noted that parties could and regularly did contract around the American Rule.  The U.S. Trustee objected, and Judge Walrath approved Brown Rudnick’s retention while reserving judgment on the fee defense provision.

The U.S. Trustee took issue with Brown Rudnick’s narrow interpretation of Asarco, and argued that estate professionals could not use Section 328’s retention provisions to avoid Section 330’s prohibition on fee shifting.  He further argued that fee defense provisions are not “reasonable” and cannot be approved under Section 328.

After requesting further briefing, Judge Walrath carefully weighed the arguments before coming down unequivocally on the side of the U.S Trustee on each one.

Judge Walrath first determined that Section 328 did not by itself create an exception to the American Rule, as it makes no mention of awarding fees or costs in the context of an adversarial proceeding. She noted by contrast that several discrete Bankruptcy Code provisions do contain express language providing for payment of fees to a prevailing party, and concluded that the absence of such express language was evidence of Congressional intent not to create an exception to the American Rule in Section 328.

She next considered Brown Rudnick’s argument that nothing in Section 328 prevented the Committee and Brown Rudnick from agreeing contractually in Brown Rudnick’s retention agreement for the payment of defense fees. She agreed that Section 328 contained no such prohibition, but rejected the argument that the retention agreement could, by itself, effect an exception to the American Rule, because in the end it would be Boomerang Tube’s bankruptcy estate, a non-party to the retention agreement, that would bear the costs.

Finally, Judge Walrath agreed with the U.S. Trustee’s argument that fee shifting provisions are not “reasonable” within the meaning of Section 328. Brown Rudnick contended that such provisions should be viewed as similar to the type of exculpation and indemnification provisions that are typically approved under Section 328 in retention agreements for investment bankers and financial advisors.  Judge Walrath found the analogy unpersuasive.  She noted that indemnification provisions are routine for investment bankers outside of bankruptcy, whereas lawyers are not commonly entitled to reimbursement for the costs of defending their fees.

Judge Walrath concluded her opinion by expressly warning other professionals not to parse her decision to find other possible ways to avoid Asarco: “Such provisions are not statutory or contractual exceptions to the American Rule and are not reasonable terms of employment of professionals.”

Judge Walrath’s decision in Boomerang Tube will undoubtedly be cited and followed by many other judges, but it will not resolve the issue.  Threats to contest estate professionals’ fees are an ingrained part of the hard-nosed negotiating process that is the hallmark of chapter 11 practice.  It is therefore inevitable that law firms will be making similar attempts to protect themselves in other districts.  As her opinion shows, these are not easy questions, and the strong likelihood is that there will be some courts that come out the other way.  This issue will probably come before the Supreme Court again.

Were the Energy Future Holdings and Caesars Chapter 11 Cases Just Saved by K Street Lobbyists?

Bankruptcy and restructuring professionals usually do not need to be political junkies. Amendments to the Bankruptcy Code, and the accompanying machinations of the Congressional legislative process, typically occur at a glacial pace, and such changes nearly always affect future rather than current chapter 11 cases.  However, the federal tax and spending bill approved by Congress earlier this month, passed in the usual whirlwind of year-end activity and horse trading, nearly derailed the pending reorganizations of two of the largest chapter 11 cases ever filed, Energy Future Holdings Corp. (“EFH”) and Caesars Entertainment Operating Company (“Caesars”).  (Kelley Drye & Warren LLP represents creditors of both EFH and Caesars, but has had no involvement in the matters discussed here.)

The bill initially contained language intended to eliminate certain tax advantages of real estate investment trusts (“REITs”).  Such structures are central components of the chapter 11 plans for both enterprises.  Had the bill passed with the language unmodified, it could have been devastating for both companies.  The blow would have been particularly keen for EFH, which only a few days earlier had succeeded in getting its plan of reorganization confirmed, following months of work by an army of bankruptcy professionals and a multi-day hearing.  The proposed REIT limitation language could have prevented the plan from ever becoming effective.

REITs are entities designed to hold real estate assets and provide investors with numerous tax breaks.  The EFH plan is centered around an unusual strategy of permitting certain creditors to invest in a new REIT structure to take control of EFH’s public utility assets, an approach projected to attract enough new capital to pay most of EFH’s remaining creditors in full immediately upon the effectiveness of the Plan.  Although the Caesars case remains mired in contentiousness and is at best several months away from having a plan confirmed, all plans proposed to date in Caesars have similarly been centered on transferring various hotel and casino properties to a REIT structure.

In recent years, a number of companies with substantial real estate assets, such as Sears and Darden Restaurants (owner of the Olive Garden chain), have transferred those assets into REITs and then leased them back, moves that have resulted in aggregate tax savings of over $21 billion. Certain members of Congress view these types of transactions as an abuse of the REIT structure, and inserted provisions in the tax and spending bill designed to curb them.

The REIT limitation language was contained in the initial version of the tax and spending bill that was released on December 7. It is unlikely that more than a handful, if any, of the bankruptcy professionals in the EFH and Caesars cases were aware of the threat posed by the tax and spending bill (and a review of bankruptcy-related news services turns up no mention of the REIT limitation proposal), but business persons at both EFH and Caesars spotted the danger.  Lobbyists for both companies immediately began pressing the case that any changes to the tax benefits of REITs should be prospective only, as it would have a huge negative impact on several companies to disrupt deals that had already been announced.  A crucial ally was found in Sen. Harry Reid of Nevada, a state heavily reliant on the strength of the gaming industry and therefore the continued viability of Caesars.

Sen. Reid also sought unsuccessfully to help Caesars by adding language to the tax and spending bill which would have amended another federal statute, the Trust Indenture Act (“TIA”).  The proposed TIA change was intended to defuse a litigation threat to Caesars, but it drew significant opposition from numerous financial institutions, hedge funds and academics, and was removed.  Withdrawing the proposed TIA amendment language may have given Sen. Reid a bargaining chip to push through the necessary protective fix with respect to the REIT proposal.  In any event, by the time the bill made it to President Obama’s desk for signature on December 18, an additional fifty-four words that insulated EFH and Caesars had been inserted to the language governing the REIT changes:

The amendments made by this section shall apply to distributions on or after December 7, 2015, but shall not apply to any distribution pursuant to a transaction described in a ruling request initially submitted to the Internal Revenue Service on or before such date, which request has not been withdrawn and with respect to which a ruling has not been issued or denied in its entirety as of such date.

The threat to the REIT transactions for EFH and Caesars was averted and, for EFH creditors especially, it remained a merry Christmas.

GM Judge Nuances His Earlier Rulings and Sets Out Permissible Ignition Switch Lawsuits

At a hearing in late August, Judge Robert Gerber expressed his annoyance with both sides in the ongoing battle to determine whether General Motors LLC (“New GM”), the entity formed in 2009 to acquire the assets of General Motors Corporation (“Old GM”), is shielded from lawsuits based on ignition switch defects in cars manufactured prior to New GM’s acquisition of the assets of Old GM in 2009. He chastised the parties for being “insufficiently nuanced” in their interpretations of his decisions earlier this year on the extent to which New GM could face liability for economic damages stemming from the defects, which allegedly caused numerous deaths and injuries, and which were known by employees of Old GM but were not properly reported (or may have been deliberately covered up).

Not surprisingly, a lengthy opinion issued by Judge Gerber last week on two crucial ancillary issues – could knowledge of Old GM regarding the scope of the ignition switch defects be attributed to New GM, and, relatedly, whether New GM is liable for punitive as well as compensatory damages – was an exemplar of nuance.  Judge Gerber finely parsed those questions and made subtle but meaningful distinctions between Old GM actions, which cannot be a basis for New GM liability, and knowledge of Old GM that became knowledge of New GM under principles of imputation and for which New GM could be liable.  (Kelley Drye & Warren LLP represents certain major creditors of Old GM but has had no role in these proceedings.)

As widely reported, Judge Gerber previously ruled that most of the lawsuits against New GM are barred by the provisions of the Sale Order he entered at that time, which transferred the assets to New GM “free and clear” of claims against Old GM (other than a narrow range of expressly assumed liabilities) and protected New GM from any claims based on theories of successor liability.  However, he also held that New GM could not claim protection under the Sale Order against liabilities based solely on its own post-sale conduct, and said that he would permit lawsuits in other courts based on such allegations against New GM to move forward.  The August hearing was held to determine which of the pending actions satisfied Judge Gerber’s requirement of being independent claims against New GM.

At the end of that hearing, Judge Gerber directed counsel for New GM to submit to him marked copies of the complaints in the pending lawsuits, showing specifically which causes of action New GM believes are grounded in the behavior of Old GM and should be barred by the Sale Order. He also requested briefs with regard to the issues of imputation of knowledge and punitive damages.  Judge Gerber was determined, as he put it at a subsequent hearing in October, to fulfill the role of “gatekeeper” in terms of construing the Sale Order and his opinions from earlier this year, and to decide once and for all (albeit subject to appeals) the types of claims which could get past the “bankruptcy gate” and proceed in other courts.

Judge Gerber made clear during the October hearing just how narrow a needle’s eye he intended to thread.  He stated that he would have no tolerance for causes of action based on theories of successor liability, no matter how they might be “dressed up” to resemble something different.  On the other hand, he also said that independent claims against New GM could be based on “inherited” knowledge.  The distinction would depend on the specificity of the allegations of knowledge and the rules governing imputation under the state law governing each specific action.

Thus, for example, Judge Gerber ruled in last week’s opinion that any causes of actions referring to New GM as a “mere continuation” of Old GM, or that elided the distinctions between Old GM and New GM, would be barred as grounded in successor liability.  Claims stating that “New GM knew,” however, would be permitted to go forward and satisfy a high but by no means impossible standard:

[P]laintiffs will have to prove the New GM knowledge they allege, on the part of identified human beings, and by identified documents to the satisfaction of . . . any . . . court hearing those claims – and by competent proof, not on theories that New GM was a “successor” to Old GM.

Judge Gerber applied a similar analysis to the issue of punitive damages. While making clear that punitive damages could not be based on the knowledge or conduct of Old GM, “or anything else that took place at Old GM[,]” and had to be based on “New GM knowledge and conduct alone[,]” he nevertheless also ruled that “New GM might have acquired relevant knowledge when former Old GM employees came over to New GM or New GM took custody of what previously were Old GM records.”  But the plaintiffs would need to show that such knowledge was “acquired in fact, and not by operation of law (such as any kind of successorship theory).”

Judge Gerber emphasized that imputation and punitive damages were ultimately matters to be determined under applicable nonbankruptcy law, and that he was not making any substantive rulings on these issues:

[The Court] has ruled simply that allegations of imputation to New GM premised on the knowledge of New GM employees, or documents in New GM’s files, get through the bankruptcy gate. After that, issues as to the propriety of imputation in particular contexts in particular cases are up to the judges hearing those cases.

It was clear from Judge Gerber’s earlier rulings that New GM would be required to defend itself in lawsuits that seek damages based solely on New GM’s post-sale actions and conduct, and the fact that such claims would possibly involve automobiles or parts manufactured by Old GM would not provide New GM with a shield under the Sale Order. Last week’s decision splits innumerable hairs, but delineates the extent to which the Sale Order protects New GM and the hurdles that the plaintiffs will need to clear to the satisfaction of other judges in order to get their claims past the bankruptcy “gate.”