The treatment of make-whole premiums in solvent debtor chapter 11 cases has become an important issue in recent years for corporate issuers and bondholders.  This post will examine a recent decision in the Hertz case by Judge Mary Walrath of the U.S. Bankruptcy Court for the District of Delaware on the allowance of such claims.  (Judge Walrath also addressed other topics in her decision pertaining to the treatment of unimpaired creditors and postpetition interest, which will be examined in a separate post.)

Value fluctuations stemming from the pandemic disruption, the subsequent rapid recovery, and ongoing volatility and uncertainty means that more solvent debtor cases can be expected moving forward into 2022.  Given the influence of the Delaware Bankruptcy Court in large chapter 11 cases, Judge Walrath’s detailed analysis in Hertz of the indenture language and applicable Bankruptcy Code provisions will inform the calculations of debtors and bondholders during plan negotiations in such cases.


The Hertz Corporation filed for protection under chapter 11 of the U.S. Bankruptcy Code in May 2020, its business decimated by the Covid-19 pandemic.  In little more than a year, however, it had recovered so successfully that it was able to propose a plan of reorganization that purported to pay unsecured creditors in full.

Hertz claimed that under its plan, the holders of its over $2.7 billion of unsecured bonds, issued pursuant to four separate indentures with maturity dates in 2022, 2024, 2026 and 2028, were “unimpaired.”  The bondholders disputed that their claims were unimpaired because, among other things, the plan did not provide for payment of $272 million of make-whole premiums (a common type of payment required under bond indentures in the event that the issuer chooses to redeem; i.e., repay the bonds ahead of the scheduled payment date) which the bondholders asserted were due under the terms of the indentures.

The two sides agreed to let the plan proceed to confirmation and have Judge Walrath determine afterwards what the bondholders were entitled to receive as unimpaired creditors.  Post-confirmation, Hertz moved to dismiss the bondholders’ claims for the make-whole premiums.

Key Issues:

Hertz denied that it had an obligation to pay the make-whole premiums, arguing that (i) none were owed under the terms of the indentures, and (ii) the claims for a make-whole premium should be disallowed as “unmatured interest” under section 502(b) of the Bankruptcy Code.

In her decision on Hertz’s motion to dismiss the claims, Judge Walrath first considered the provisions of the indenture governing the “acceleration” of the bonds upon the bankruptcy filing, and addressing the “redemption” (i.e., voluntary early repayment) of the bonds.  She then examined whether the “maturity” of the bonds could occur ahead of the scheduled payment date.  Finally, Judge Walrath looked at the Bankruptcy Code to resolve whether the make-whole premium claims, even if payable under the terms of the indentures, should nevertheless be disallowed as “unmatured interest.

Judge Walrath’s Analysis

Acceleration – Hertz contended that no make-whole premiums were owed because the acceleration provision in the indentures spoke only of principal and accrued interest under the bonds becoming immediately due upon a bankruptcy filing, with no mention of any premium.

Judge Walrath rejected this argument.  She noted that under Energy Future Holdings (“EFH”), the leading case on make-whole premiums in the Third Circuit, the acceleration clause was not applicable.  She held instead that the redemption clause, which expressly provided for payment of the make-whole premium upon an early voluntary repayment, was the “operative” provision.

Redemption – Hertz next asserted that the redemption provision should not apply, because the early repayment of the bonds was not a voluntary decision by Hertz, but was instead required as a result of the bankruptcy filing.  The Second Circuit made such a ruling in the MPM Silicones case.

Although the Third Circuit in the EFH case ruled to the contrary, and held that a payment under a bankruptcy plan constituted a voluntary early repayment that triggered an obligation to pay a make-whole premium, Hertz asked Judge Walrath to distinguish that decision.  The EFH case had been commenced with the specific purpose of trying to avoid the payment of a make-whole premium, while Hertz had no such intent when it filed.

Judge Walrath, however, declined Hertz’s invitation to disregard EFH and apply MPM.  She agreed instead with the bondholders, who argued that regardless of whether Hertz had filed for bankruptcy with any specific intent to avoid payment of the make-whole premiums, the filing itself was a “strategic, voluntary decision[.]”  The subsequent repayment of the bonds under the bankruptcy plan was therefore a voluntary early repayment that constituted a redemption and triggered the obligation under the indentures to pay the make-whole premiums.

Maturity – Hertz had one further argument as to why the make-whole premiums were not payable under the terms of at least two of the indentures.

The indentures for the 2022 and 2024 bonds stated that the make-whole premiums would be payable if the bonds were redeemed after a specified date but “prior to maturity.”  The other two series of bonds, the 2026 and 2028 bonds, omitted the words “prior to maturity.”

Hertz contended that the reference to “maturity” included the acceleration due to the bankruptcy filing, and that the payment of the 2022 and 2024 bonds under the plan was therefore a redemption after “maturity.”  Judge Walrath agreed, and dismissed the claims for the make-whole premiums with respect to the 2022 and 2024 bonds.

Economic Equivalent of Interest – Judge Walrath next considered whether the remaining make-whole premium claims with respect to the 2026 bonds and the 2028 bonds should be disallowed under the Bankruptcy Code.  Section 502(b) of the Bankruptcy Code expressly disallows claims for “unmatured interest,” i.e, interest which had not yet accrued as of the commencement of the case.  Hertz argued that the make-whole premiums were the economic equivalent of future unpaid interest and could not be allowed under section 502(b).

The bondholders countered that the make-whole premiums are not future unpaid interest but are instead a liquidated damages provision “intended to compensate the [bondholders] for the uncertainty and potential losses incurred in reinvesting that money in a different market environment, which implicates numerous factors beyond simply the periodic payment of interest.”  The bondholders pointed to a recent decision by Judge Marvin Isgur in the Southern District of Texas who, faced with similar issues in the case of Ultra Petroleum Corp., ruled that a make-whole premium did not constitute future unpaid interest and would not be disallowed under section 502(b).

Judge Walrath acknowledged Ultra Petroleum and other similar cases cited by the bondholders.  At the same time she expressed concern that the premium is ultimately “calculated, in large part, on the present value of the unmatured interest due on the [bonds] . . . .”  She determined that the nature of the make-whole premiums presented a question of fact that would require an evidentiary hearing.

Since she was ruling on Hertz’s motion to dismiss the make-whole premium claims as a matter of law, she declined to disallow the claims under section 502(b).  The bondholders, however, will need to present evidence at a future hearing that the make-whole premiums are not the economic equivalent of future unpaid interest.

A recent decision reminds creditors of the harsh consequences of failing to comply with a court imposed deadline for filing claims in a bankruptcy case. The U.S. Court of Appeals for the Third Circuit recently held in Ellis v. Westinghouse that claims accruing after confirmation of a chapter 11 plan, but  before the plan goes effective, are subject to the administrative claim deadline established by the plan. Absent a few narrow exceptions, creditors that fail to file an administrative claim by the deadline risk having their claims discharged. This first impression decision directly impacts creditors with claims that accrued during the post-confirmation, pre-effective date period, including contract counterparties, landlords, employees, unpaid suppliers, and equipment lessors.

Westinghouse filed for chapter 11 bankruptcy relief in March 2017 and confirmed its plan on March 28, 2018. The plan required creditors to file claims for administrative claims, those relating to obligations arising post-petition, within 30 days after the plan’s effective date, or such claims would be forever discharged. Timothy Ellis was a vice president of Westinghouse, and on May 31, 2018, two months after the bankruptcy court confirmed the plan, but prior to the plan going effective, Ellis was terminated. Ellis believed he was wrongfully terminated because of his age.

Westinghouse’s plan went effective on August 1, 2018, five months after it was confirmed. Westinghouse sent creditors a notice of the effective date of the plan which included a reminder to file administrative claims by August 31, 2018, the deadline set by the plan. Both Ellis and Westinghouse agreed that Ellis’ employment claim accrued on his termination date, giving Ellis 91 days before the deadline to file his claim with the bankruptcy court.

Ellis, however, did not file a claim by the August 31, 2018 deadline. Instead, on October 2018, Ellis filed a lawsuit against Westinghouse for employment discrimination. In response, Westinghouse filed a motion for summary judgment, asserting that the plan discharged Ellis’ claim. The district court denied Westinghouse’s motion, concluding that the bankruptcy code cannot discharge or create a bar date for claims that arose post-confirmation but pre-effective date.

The Third Circuit disagreed and reversed the district court, holding that the bankruptcy code authorizes bankruptcy courts to set deadlines for post-confirmation, pre-effective date claims, and that claims that are filed late may be discharged.

Although creditors have a few exceptions, the result is harsh.  First, the bankruptcy code allows creditors to file untimely administrative claims after showing “cause” for the delay. Additionally, administrative claim deadlines must comply with due process, so a claim is only subject to discharge if a creditor received adequate notice of the bankruptcy and had a fair opportunity to press the claim.  Neither exceptions appears to apply to Mr. Ellis’ situation.

The Ellis v. Westinghouse decision is the first ruling by a U.S. Court of Appeals regarding the discharge of claims accruing post-confirmation, but prior to the a plan effective date. Other Courts are likely to follow the Third Circuit’s reasoning, so creditors should carefully follow a plan’s administrative claim deadline or otherwise have their claims discharged.

Two recent judicial decisions, Sanchez Energy and Tribune Media, highlight the challenges faced by indenture trustees and their professionals in chapter 11 cases where there are no recoveries to noteholders.  Federal law requires that public debt be issued under a trust indenture and that a qualified financial institution serve as trustee to protect noteholders’ interests.  The payment of fees and expenses incurred under these indentures when the issuing company goes into bankruptcy, particularly the fees and expenses of attorneys and other professionals retained by trustees to assist them in their duties to noteholders, often becomes a contentious issue.

If there are sufficient funds in the bankruptcy estate to provide at least a partial recovery to noteholders, the indenture trustee may assert a right of priority payment for its fees and expenses under the indenture against such recovery, commonly referred to as the “charging lien.”  However, in cases where there are no distributions to noteholders, indenture trustees must establish a legal basis for payment from the debtor, either as a contractual right under the terms of the indenture or as a statutory right under the Bankruptcy Code.  The judges in Sanchez Energy and Tribune Media adopted narrow interpretations of these respective rights and denied the requested payments.

Sanchez Energy

In Sanchez Energy Corporation, Case No. 19-34508 (Southern District of Texas), Judge Marvin Isgur took a limited view of an indenture trustee’s statutory right to payment.  The indenture trustee (the “IT”) sought payment of its fees and expenses in the amount of approximately $930,000 as an administrative priority claim under section 503(b)(1)(A) of the Bankruptcy Code, arguing that such fees and expenses were part of the “actual, necessary costs and expenses of preserving the [bankruptcy] estate[.]”  Claims allowed under section 503(b)(1)(A) are entitled to payment ahead of all other unsecured claims and must be paid in full in order for a chapter 11 plan to be confirmed.

Under section 503(b)(1)(A), a claim may be considered a “necessary” expense of administration if it confers a benefit to the debtor and its bankruptcy estate.  The IT pointed to a number of services that it undertook during the course of the chapter 11 case which purportedly benefitted the debtor.  Among other things, the IT highlighted the notices of key case developments which it provided to noteholders, its service as a member of the official committee of unsecured creditors, and its role in negotiating an overall settlement and certain important documents in connection with the debtor’s reorganization.  The IT further contended that its continued service as indenture trustee in and of itself was a benefit to the debtor, allowing it to comply with its obligations under federal securities law.

Judge Isgur disagreed.  Although he acknowledged the tasks undertaken by the IT and that the debtor and its estate may have benefitted from its efforts, he ruled that a higher standard applied.  Judge Isgur noted that sections 503(b)(3)(D), 503(b)(4), and 503(b)(5) of the Bankruptcy Code specifically refer to “an indenture trustee” as a party which can assert an administrative priority claim based on “making a substantial contribution in a case under [chapter 11].”  Specifically, Judge Isgur held that those provisions require that an indenture trustee must show more than merely a “benefit” to the debtor from its services, and that it actually made a “substantial contribution” to the chapter 11 case.  Allowing an administrative claim for an indenture trustee under the lower “benefit” standard section 503(b)(A)(1) would, in Judge Isgur’s view, make sections 503(b)(3)-(5) “mere surplusage.”

Utilizing the higher requirements for establishing a “substantial contribution,” Judge Isgur rejected administrative priority status for all but a fraction of the IT’s asserted claims.  Judge Isgur held that the trustee’s actions needed to have actually “foster[ed] and enhance[ed] . . . the progress of reorganization.”  The only actions of the IT that satisfied this higher standard, Judge Isgur determined, were certain of its notifications to noteholders, to the extent that such notices effectively relieved the debtor of that responsibility.  However, such work only accounted for a small fraction – less than 1%  –  of the IT’s requested fees and expenses.

Tribune Media

Tribune Media Company, Case No. 08-13141 (District of Delaware), is among the largest and most contentious chapter 11 cases in recent memory.  Judge Brendan Shannon noted that the dispute alone over the fees of the IT for a series of subordinated notes “has been negotiated, mediated, and litigated up to the Third Circuit and back” over several years.  The dispute that recently wound up back in front of Judge Shannon turned on whether, under the contractual terms of the indenture, the IT could establish a claim for attorneys’ fees for services rendered by its counsel but for which the IT had no direct liability to pay.

In Tribune Media, the IT had retained counsel that undertook, among other services, a detailed investigation of a pre-bankruptcy leveraged buyout, and litigated extensively on behalf of the noteholders throughout the lengthy chapter 11 case.  Although there were no recoveries under the chapter 11 plan on account of the subordinated notes, the plan provided that the IT could seek payment of fees and expenses allowable under the terms of the indenture as a general unsecured claim and receive a recovery of approximately 33%.  The total fees sought exceeded $30 million.

The IT pointed to standard language in the indenture that required the debtor “to reimburse the Trustee . . . for all reasonable expenses, disbursements and advances incurred or made by the Trustee . . . including the reasonable compensation and the expenses and disbursements of its agents and counsel[.]”  Other sections of the indenture entitled the IT to be paid, upon the occurrence of a default, “the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel[,]” and “[i]n the pendency of any … bankruptcy” to be paid “any amount due it for the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel[.]”

The debtor countered that these provisions should be read narrowly, and that the IT had not actually “incurred” most of the fees being sought.  Under the terms of the engagement letter, the IT and the law firm providing the services at issue had agreed that the IT would have no liability for payment of professional fees other than $3 million that two large noteholders provided to the IT for that express purpose.  Beyond that, the law firm was effectively working on a contingent fee basis, based on any recoveries on the subordinated notes.

Judge Shannon agreed with the debtor that an expense could only be “incurred” for purposes of “reimbursement” under the indenture if the IT were actually liable for payment, and held that the IT’s fees should be limited to $3 million.  He dismissed the IT’s arguments regarding customary market practice, under which indenture trustees rarely pay fees out of pocket prior to seeking reimbursement:

The Court is not requiring an indenture trustee to advance payment of fees and costs, but it is requiring that an indenture trustee be liable to pay those costs either out of its pocket or from distributions received. Asking Tribune to pay more than the amount that [the IT] is obligated to pay – – that is, the amount of fees that [the IT] incurred – – is tantamount to giving [the IT’s] professionals a blank check.


Judge Isgur and Judge Shannon, influential and respected judges in two of the country’s busiest districts for large chapter 11 cases, have taken limited views of an indenture trustee’s statutory and contractual rights in their respective decisions in Sanchez Energy and Tribune Media.  It is possible that the impact of Tribune Media may be mitigated to some extent by careful drafting of engagement letters, to establish that an indenture trustee has “incurred” professional fees without disrupting customary market practice.  Sanchez Energy, however, with its narrow reading of an indenture trustee’s ability to establish an administrative priority claim under section 503(b) of the Bankruptcy Code, will unquestionably make it more difficult for indenture trustees and their professionals to recover fees and expenses in cases where there are no recoveries for noteholders.

The U.S. Court of Appeals for the Third Circuit recently became the first circuit court to address the question of whether a corporate parent can set off an obligation that it owes to a bankrupt company against a claim owed by such company to the parent’s subsidiary. A couple of years ago, in the chapter 11 case of Orexigen Therapeutics in the District of Delaware, former Bankruptcy Judge Kevin Gross denied a motion to allow such a “triangular” setoff. Last month, the Third Circuit affirmed, handing down a clear opinion that should largely put to rest an issue that has vexed debtors and creditors in numerous chapter 11 cases. (Kelley Drye & Warren LLP represents the indenture trustee for the holders of certain secured notes in Orexigen Therapeutics, but took no part in the matters discussed here).

The doctrine of setoff allows for debts to be cancelled out, in order to avoid what has been described by courts as the inequity of forcing a non-bankrupt party to pay its obligation to a bankrupt party in full, while only receiving back a small fraction of its claim. The right of setoff thereby creates a significant exception to a fundamental policy underlying the Bankruptcy Code, which is that similarly-situated creditors should receive similar treatment.

The facts in Orexigen Therapeutics are straightforward.  Orexigen, a pharmaceutical company, filed for chapter 11 in March 2018.  Prior to its bankruptcy, Orexigen entered into a distribution agreement with a company (“Parent”), and a separate services agreement with Parent’s subsidiary (“Subsidiary”).  At the time of the bankruptcy filing, Parent owed nearly $7 million to Orexigen under the distribution agreement, and Orexigen owed approximately $9.1 million to Subsidiary. The terms of the distribution agreement stated that obligations owed by Parent to Orexigen could be set off against debts owed by Orexigen to any affiliate of Parent.

A sale of substantially all of Orexigen’s assets fell significantly short of the amounts owed to Orexigen’s secured creditors, leaving unsecured creditors with claims worth no more than a few cents on the dollar at best.  Knowing that Subsidiary’s claim would otherwise be virtually worthless, Parent sought permission to exercise its right under the distribution agreement to effectuate a triangular setoff and apply the amounts owed by Parent to Orexigen against the amounts owed by Orexigen to Subsidiary.

Section 553 of the Bankruptcy Code recognizes the right of setoff in bankruptcy to the extent that it may be available to a creditor under applicable state law, but only so long as the debts to be set off are “mutual”. Aware that courts have construed the mutuality requirement to mean that the debts to be set off against each other be due to and from the same persons or entities in the same capacity, Parent argued that the key factor instead was whether Parent would have had a cognizable right of setoff outside of bankruptcy. Seeking to minimize the importance of the “mutuality” requirement, Parent emphasized that the distribution agreement expressly provided that Parent could set off amounts it owed to Orexigen against amounts owed to any of Parent’s affiliates or subsidiaries, and that California law, which governed the distribution agreement, permitted such triangular setoffs.

The Third Circuit disagreed. The “mutuality” requirement set forth in section 553, it held, is a limiting term, and it dismissed Parent’s contention that parties could contractually work around “mutuality”. In reaching this determination, the Third Circuit panel adopted the reasoning of Judge Brendan Shannon in In re SemCrude,L.P., an earlier Delaware Bankruptcy Court opinion on which Judge Gross had relied. In rejecting a similar effort to enforce a contractual triangular setoff right, Judge Shannon had determined that the mutuality requirement of Section 553 compelled the disallowance of such setoffs, because the debts were owed to and from different corporate entities. Judge Kent Jordan, writing for the unanimous Third Circuit panel, stated, “[We] agree with and adopt the SemCrude court’s well-reasoned conclusion that Congress intended for mutuality to mean only debts owing between two parties . . . [and that] Congress did not intend to include within the concept of mutuality any contractual elaboration on that kind of simple, bilateral relationship.”

The Orexigen decision is the first ruling by a U.S. Court of Appeals on triangular setoffs. Given the ubiquity of dealings among related corporate entities, and the minimal recoveries usually obtained by unsecured creditors in chapter 11 cases, it can be expected that there will be further attempts to effectuate triangular setoffs in bankruptcy cases outside of the Third Circuit. However, despite the creative arguments that counsel for such creditors are likely to develop and assert, it can reasonably be expected that the Third Circuit’s reasoning will be followed in most cases, and that triangular setoffs in bankruptcy are effectively a dead letter.

A recent decision by Judge Jed Rakoff of the Southern District of New York highlights the risks faced by directors and officers of companies in financial distress who fail to undertake properly their duties to the company and its stakeholders. In mostly denying a motion to dismiss claims brought against former directors and officers of Nine West Holdings and Jones Group, its predecessor company, Judge Rakoff’s opinion highlights the limits of protective legal doctrines such as the business judgment rule, which typically shields from subsequent inquiry corporate decisions made in good faith and with appropriate care, and prophylactic measures such as the delivery of solvency opinions.

In 2014, Jones Group, the financially distressed owner of footwear and apparel brands such as Nine West, Anne Klein, and Gloria Vanderbilt, was taken private in a leveraged buyout by private equity firm Sycamore Partners and became Nine West Holdings. When Nine West Holdings filed for bankruptcy in 2018, creditors unsurprisingly began scrutinizing the acquisition effectuated four years earlier. Potential claims against Sycamore in connection with the 2014 transactions were resolved as part of the chapter 11 case. Claims against former directors and officers of Jones Group were not settled and were given over to a litigation trust for prosecution on behalf of Nine West Holdings’ creditors following the confirmation of the chapter 11 plan.

Broadly stated, the 2014 acquisition of Jones Group was initially proposed to involve five separate transactions:

  • Jones Group was first to merge with a Sycamore affiliate to become Nine West Holdings.
  • Sycamore committed to contribute $395 million in equity to Nine West Holdings.
  • Following the merger of Jones Group with the Sycamore affiliate, Nine West Holdings, which already had $1 billion in debt on its balance sheet, would take on additional debt of $200 million.
  • The former Jones Group shareholders would receive $1.2 billion ($15 per share).
  • Also following the merger, certain valuable brands would subsequently be carved out of Nine West Holdings and sold to a separate Sycamore affiliate for less than fair market value.

The claims brought by the litigation trustee primarily focused on alleged breaches of fiduciary duty by Jones Group’s former directors and alleged fraudulent transfers to Jones Group’s former officers. Certain key facts considered by Judge Rakoff:

  • The terms of the transactions changed prior to the closing of the merger and became much less favorable for Nine West Holdings. Sycamore’s equity commitment was reduced to $120 million, and Nine West Holdings’ debt load increased by an additional $350 million, to $1.55 billion.
  • An investment banker engaged by the Jones Group’s board in 2012 had advised that the company could support a debt ratio of 5.1 times its projected 2013 earnings. However, the changed terms meant that Nine West Holdings would have a debt ratio of 7.8 times its projected earnings. Moreover, Nine West Holdings’ earnings would no longer include revenue from the brands being carved out and sold to Sycamore separately.
  • The Jones Group directors went forward with the merger despite the change in terms, even though they had the right to terminate the transactions under a “fiduciary out” clause in the agreements. Although the vote to approve the merger did not include approval of the increase in debt for Nine West Holdings and the sale of the carved-out brands, the Jones Group directors were aware that those transactions were expressly contemplated as part of the overall deal structure.
  • Following the merger, new directors were appointed for Nine West Holdings, and the new directors approved the transactions to increase the debt and to sell the carved-out brands.
  • In connection with the separate sale of the carved out brands, Sycamore engaged an investment bank to provide a solvency opinion for Nine West Holdings. The opinion concluded that Nine West Holdings had an enterprise value in excess of its contemplated debt load of $1.55 billion and was therefore solvent. However, the investment bank used earnings projections expressly provided by Sycamore and did not undertake an independent analysis.
  • Following the merger, Jones Group officers received “change of control” payments from Nine West Holdings ranging from $450,000 to $3 million.

The former Jones Group directors requested dismissal of the claims that they breached their fiduciary duties to the company and its stakeholders on the basis of the business judgment rule. Corporate laws vary from state to state, but the business judgment rule, as described by Judge Rakoff, typically protects decisions made by corporate directors and officers that were made (i) in good faith, (ii) by persons who have no financial interest in the subject of the decision, (iii) by persons reasonably and properly informed with respect to the subject of the decision, and (iv) with a reasonable basis for the belief that the decision was in the best interests of the corporation. The directors further sought the dismissal of claims with respect to the increase in debt and sale of the carved-out brands transactions undertaken by Nine West Holdings following the merger.

The former officers sought dismissal of the claims that the change of control payments constituted constructive fraudulent transfers which could be recovered by the litigation trustee. A constructive fraudulent transfer requires a showing that the transferor was insolvent at the time of the transfer was made and did not receive reasonably equivalent value in return. The former officers contended that the solvency opinion obtained by Sycamore for Nine West Holdings established that Nine West Holdings was not insolvent at the time that the payments were made, and that one of the necessary elements of a constructive fraudulent transfer therefore could not be shown.

Judge Rakoff declined to dismiss most of the claims. In determining that the former Jones Group directors were not shielded by the business judgment rule, he concluded that they had failed to undertake an appropriate investigation into whether the five transactions, taken as a whole, would damage the company by rendering it insolvent, particularly after the deal terms were unfavorably changed. He further ruled that the directors could not escape potential liability for the post-merger debt and sale transactions even though they were approved by a subsequent board of directors. Noting that the former Jones Group directors had expressly disclaimed undertaking any independent investigation of those transactions, he pointedly observed that “the business judgment rule presupposes that directors [actually] made a business judgment[.]” Those directors, he held, even after having been expressly informed that the debt ratio of the post-merger company would substantially exceed the maximum recommended limit, ignored numerous “red flags” as to the potential negative impact of the post-merger transactions, and therefore could not claim the protections of the business judgment rule.

The fraudulent transfer claims against the former Jones Group officers also mostly survived dismissal. Judge Rakoff gave short shrift to the officers’ contentions that the solvency opinion obtained by the investment bank engaged by Sycamore provided any protection in this regard, referencing the litigation trustee’s allegations that it was based on “Sycamore’s allegedly bloated enterprise value, which was alleged to have been specifically engineered to be ‘just above the $1.55 billion of debt.’” He particularly noted the impact of the loss to Nine West Holdings of the value of the carved-out brands in ruling that insolvency could readily be inferred from the litigation trustee’s allegations, and that the trustee could therefore proceed to trial on those claims.

The rulings in the Nine West D&O litigation serve as an important reminder to corporate directors and officers that there are limits to the protection from liability that legal doctrines such as the business judgment rule, and transactional protections such as solvency opinions, can provide when major decisions regarding a company in financial distress are being made. Given the extensive review that will be undertaken if a company subsequently falls into bankruptcy, extra care must be taken to show that potential red flags have been properly considered and weighed, and that any relied-upon work product provided by professional advisors is derived from genuinely independent analysis.


The much-ballyhooed COVID relief bill passed by Congress at the end of last year, in addition to providing for $600 checks to millions of people, includes several COVID-related amendments to the U.S. Bankruptcy Code. Some of these changes will have a significant direct impact, at least temporarily, on the rights of commercial landlords and tenants in chapter 11 cases.

  • The bill amends Section 365(d)(4) of the Bankruptcy Code, which provides that a commercial property lease is deemed rejected unless it is assumed by a debtor within 120 days following the filing of the bankruptcy case. The 120 day period has been increased by an additional 90 days, so that a debtor will now have 210 days after commencing the case to decide whether to assume or reject a commercial property lease.
    • Under existing law the bankruptcy court already has the discretion at the request of a debtor to increase this period by 90 days; accordingly, a debtor can now have up to 300 days to decide whether to assume or reject the lease.
    • This change to the Bankruptcy Code will sunset in two years, but will continue to apply in subchapter V small business chapter 11 cases commenced before the sunset date of December 27, 2022.
  • The bill also amends Section 365(d)(3) of the Bankruptcy Code to extend the time for a debtor to pay rent under a commercial real property lease. This change will apply only to subchapter V small business chapter 11 cases.
    • Under existing law, a debtor must begin complying with its lease obligations no later than 60 days after commencing the case. Under this amendment, if the bankruptcy court finds the debtor has experienced and is continuing to experience a material financial hardship, directly or indirectly, as a result of the COVID-19 pandemic, the court may extend this period by an additional 60 days.
    • Any claim arising from such extension shall be treated as an administrative priority expense for purposes of confirmation of a chapter 11 plan in a subchapter V small business chapter 11 case.
    • This change will sunset on December 27, 2022, but will continue to apply to any subchapter V small business chapter 11 bankruptcy case commenced before that date.
  • Another important amendment is a change to Section 547 of the Bankruptcy Code, which allows a debtor or a trustee to recover payments made by the debtor during the 90 day period prior to the commencement of the bankruptcy case.
    • Current law permits the recovery (subject to certain defenses) of payments on account of existing obligations made within such 90 day period that were outside of the ordinary course of business.
    • The amendment will protect a commercial landlord from possibly having to return any such payments if they were made under an agreement to defer rent subsequent to March 13, 2020.
    • The change is intended to encourage rent deferral arrangements between landlords and tenants. It applies only to rent payments, and not to the payment of fees, penalties, or interest the debtor may otherwise have owed without the deferral.
    • This change will also sunset on December 27, 2022, but will continue to apply to any bankruptcy case commenced before such date.


The New York Court of Appeals recently handed down an important opinion on out of court restructurings involving bond debt. In CNH Diversified Opportunities Master Account, L.P., v. Cleveland Unlimited, Inc., the Court of Appeals, in a 4–3 ruling, diverged from the Second Circuit’s ruling a few years ago in Marblegate Asset Mgt., LLC v Education Mgt. Fin. Corp. and resuscitated rights of minority bondholders under the Trust Indenture Act which were limited under Marblegate. The CNH decision, by making it easier for minority bondholders to impede remedial action taken by an indenture trustee at the direction of a majority of bondholders under a trust indenture and related documents, will result in fewer consensual out of court restructurings and require more chapter 11 filings for the implementation of such deals.

Section 316(b) of the Trust Indenture Act provides that “the right of any Holder to receive payment of principal . . . and interest . . . on a Note . . . or to bring suit for the enforcement of any such payment . . . shall not be impaired or affected without the consent of such Holder.” The Second Circuit in Marblegate rejected a challenge under Section 316(b) to an out of court restructuring that stripped nonconsenting minority unsecured bondholders of their practical ability to collect payment on their bonds. The transaction at issue in Marblegate consisted of an intercompany sale of the issuer’s assets to a new subsidiary, effectuated through a foreclosure by the holders of senior secured bank debt together with certain other steps. Unsecured bondholders were given the choice of (i) exchanging their bonds for equity in the new subsidiary, or (ii) retaining their bonds and their rights against the issuer, which no longer held any assets and was effectively an empty shell. The Second Circuit held that Section 316(b) was not violated with respect to the nonconsenting bondholders because there had been no formal amendment of the payment terms of the indenture that governed the bonds.

In CNH, following the issuer’s default, a group of bondholders representing 96.3% of the bonds negotiated a settlement which would have provided for the issuer’s parent company to distribute 100% of the issuer’s equity, which had been pledged in support of the bond debt, to a new holding company to be owned by all of the bondholders on a pro rata basis. The deal failed when the holders of the remaining 3.7% of the bonds refused to consent. As a workaround, the majority bondholders directed the indenture trustee (which was also the collateral agent) to undertake a foreclosure of the pledged equity under the Uniform Commercial Code and distribute the equity to all bondholders in full satisfaction of the debt and to cancel the bonds.

The minority bondholders commenced an action against the issuer and its affiliated guarantors to enforce the remaining amounts owed under the bonds, citing Section 316(b) and identical language incorporated in the indenture. The lower courts in CNH, relying in part on Marblegate, ruled in favor of the defendants. Those courts found that, as in Marblegate, there had been no amendment to any terms of the indenture that impaired the minority bondholders’ rights.

However, the New York Court of Appeals reversed, holding that the rights of the minority bondholders to seek payment under the bonds survived the foreclosure. Although there was no question about the authority of the indenture trustee, under the security documents that governed the pledge of the issuer’s equity, to undertake the actions it did at the direction the majority bondholders, the Court of Appeals held that the Section 316(b) language incorporated in the indenture meant that the rights of the minority bondholders to enforce the bonds could not be extinguished. The majority opinion determined that in Marblegate, even though the practical ability of nonconsenting bondholders to recover had been impaired because they were left with rights against a shell company with no assets, the legal right of such holders to enforce the bonds had remained intact.  By contrast, in CNH, the bonds were cancelled.

The dissenting opinion disagreed with the majority’s interpretation of the Section 316(b) language, and expressed concern about the confusion likely to ensue from having a split between the Second Circuit and the New York Court of Appeals on such an important issue and its likely impact on the corporate debt markets: “The majority strikes at the consistency between the law of this Court and that of the United States Court of Appeals for the Second Circuit with respect to the rules by which disputes related to an indenture of this nature are to be resolved.” The dissent also argued, among other things, that the majority opinion failed to consider the security documents and whether those documents, which were expressly incorporated by reference in the indenture, effectively evidenced the consent of the minority bondholders for the actions taken by the indenture trustee, including the cancellation of the bonds.

The Second Circuit in Marblegate limited the ability of nonconsenting minority bondholders to block a consensual arrangement between an issuer and majority bondholders. The CNH decision, in contrast, by empowering recalcitrant minority bondholders, will make consensual out of court restructurings more difficult to achieve. More issuers will need to resort to chapter 11 filings and the provisions of the U.S. Bankruptcy Code which override Section 316(b) and prevent a small minority of bondholders from impeding restructuring transactions which have the support of at least 66% of a class of bondholders. The New York Court of Appeals’ determination to distinguish Marblegate may be justifiable based on a technical reading of the language of Section 316(b). As a practical matter, however, the CNH dissent is correct that the difference in outcomes of the two rulings will create uncertainties and complicate the calculations of distressed issuers, bondholders and indenture trustees that are seeking to engage in out of court restructurings.

2020 is on pace to set a record as the busiest year for bankruptcy filings since the Great Recession.  In this episode on Kelley Drye Legal Download podcast, Bankruptcy and Restructuring Partner Bob LeHane and Special Counsel Jennifer Raviele discuss the current state of retail and restaurant bankruptcy cases, the impact of the global pandemic, and what to expect in the future.

Listeners can tune into their episode of Kelley Drye Legal Download podcast here and get future episodes on their preferred platform – Apple Podcasts, Google Play or Spotify.

The impact of COVID-19 is being felt at all levels of the economy and will work its way through bankruptcy courts for years to come.  In these early days, many creditors who are themselves suffering are providing assistance to troubled companies.  Suppliers and commercial landlords are agreeing to various forms of relief, including modified credit terms and rent relief to allow customers to bridge this period of unprecedented disruption.  While these corporate good Samaritans are providing immediate aid they may be subjecting themselves to the risk of future losses.

Consider the supplier extending terms now to a customer who inevitably files for bankruptcy.  As creditors to troubled businesses know, payments received from a debtor within 90 days of bankruptcy are subject to potential avoidance as a preference.  One of the primary preference defenses is the “ordinary course” defense, which insulates payments received in the ordinary course of business with the debtor.  The defense can be weakened if the payments at issue are made later than historic averages or eliminated if the payments are made by special arrangement.  As a result, under current law, the supplier who works with its customer and modifies payment terms to help them confront the economic fallout of COVID-19 may suffer increased future exposure because one of the most common statutory preference defenses is harder to prove.  

The risk to landlords is similar as courts have held that (i) an agreement to forbear from eviction does not insulate back rent payments from avoidance, and (ii) deferred rent payments are avoidable because payments made pursuant to unique agreements are not in the ordinary course of business.

Lenders that agree to loan amendments and forbearances to address COVID-19 will face similar concerns.  What of the lender that agrees to amend a financing agreement, extending maturity or offering interest-only terms during the crisis, and takes a lien on additional collateral as protection against the increased risk?  If the borrower ultimately files for bankruptcy, the lien on new collateral may be subject to preference attack.  

Absent fraud or other misconduct, should such creditors be penalized for working to find solutions during times of crisis?  Congress could make clear that, absent fraud or misconduct, creditor concessions granted during the COVID-19 crisis are presumptively immune from avoidance under the Bankruptcy Code.  This would protect parties that proactively step in to help, and might encourage others to do the same.  

The economic fallout from the COVID-19 pandemic will leave in its wake a significant increase in commercial chapter 11 filings. Many of these cases will feature extensive litigation involving breach of contract claims, business interruption insurance disputes, and common law causes of action based on novel interpretations of long-standing legal doctrines such as force majeure. These issues could be particularly problematic to resolve because of questions stemming from recent Supreme Court decisions regarding the constitutional authority of United States bankruptcy courts to make final rulings on these types of disputes. Fortunately, however, a recent decision by the U.S. Court of Appeals for the Third Circuit in the case of Millennium Lab Holdings suggests a different approach for addressing these constitutional concerns. The Third Circuit’s approach anticipates where the Supreme Court’s jurisprudence appears to be heading, and should provide useful guidance to bankruptcy courts during what is going to be a challenging period for both judges and practitioners.

Uncertainties regarding the authority of bankruptcy courts to issue final orders in certain types of cases have existed for decades, but were mostly quiescent until the Court’s opinion nine years ago in Stern v. Marshall.  In that case, which arose out of the endless litigation between Anna Nicole Smith and the son of her late husband, the Supreme Court stunned the commercial legal community by reopening what many had believed were long-settled constitutional questions regarding the United States bankruptcy courts.  Since then, practitioners and lower courts have struggled to deal with the ramifications of that decision.

The problems created by Stern, in a nutshell, are as follows:

Congress has the express power under Article I, Section 8 to pass uniform laws on bankruptcy. It used that power to create the modern bankruptcy court system pursuant to Article I of the Constitution rather than under Article III, the source of the federal government’s judicial power.

However, the Supreme Court has long held that “separation of powers” concerns require that Article I courts be limited to territorial courts, military tribunals, and courts created to hear cases involving “public rights” (e.g., cases involving claims of citizens against the government).  Claims of citizens against one another under state law, such as for breach of contract or common torts, are “private rights” that must be heard by an Article III judge.

Prior to Stern, it was generally believed that matters pertaining (in the Court’s words) to “the restructuring of debtor-creditor relations, which is at the core of federal bankruptcy power” under Article I, constituted a type of “public right” that could be heard and decided by an Article I bankruptcy judge.

The Court, however, never handed down a clear ruling as to where the line between “public rights” and “private rights” should be drawn in bankruptcy proceedings, even though “the restructuring of debtor-creditor relations” often necessitates the resolution of “private rights” disputes. Moreover, the Court, both in Stern and in recent non-bankruptcy cases, has significantly narrowed the “public rights” doctrine.

This has created confusion and given rise to substantial litigation in bankruptcy cases over the constitutional authority of bankruptcy judges to issue final orders on numerous issues which could implicate “private rights.”

In Millennium, the Third Circuit affirmed lower court opinions that turned aside a constitutional challenge to the authority of a bankruptcy court to confirm a plan of reorganization. The plan included the non-consensual release by third parties of certain claims against various non-debtor entities. The debtor’s equity holders had been accused of orchestrating fraudulent activity in connection with the debtor’s Medicare and Medicaid reimbursement requests.  The plan embodied a compromise, whereby the equity holders were to pay $325 million in exchange for a release of all claims against them held either by the debtor’s estate or directly by third parties.

Certain of the debtor’s lenders had commenced separate litigation against the equity holders, and objected to the releases in the plan that would preclude their claims. The lenders contended that under Stern the releases were tantamount to resolving a “private rights” dispute between two non-debtor parties, and that the bankruptcy court therefore lacked constitutional authority to enter a final order resolving it.

The Third Circuit rejected the lenders’ arguments. However, the decision avoids the thicket of the Supreme Court’s “public rights” jurisprudence, and strongly implies that such jurisprudence no longer provides support for bankruptcy courts’ constitutional authority to issue final orders which are dispositive of parties’ “private rights.” The Third Circuit reviews the Court’s recent decisions in this area and suggests that the Court is heading towards an alternative approach:

Judge Kent A. Jordan, writing for the court, steps away from the “public rights” doctrine and towards a straight-forward alternative – an express recognition that specialized bankruptcy courts under Article I should be viewed as an additional category of historical exception to the judicial power of Article III.

This would place the constitutional authority of bankruptcy courts to make dispositive rulings in cases involving “private rights” on far firmer ground than it currently rests under the “public rights” doctrine. Judge Jordan cites a passage that appears to endorse the “historical exception” rationale from a recent separate opinion by Chief Justice Roberts, who authored Stern:

“When the Framers gathered to draft the Constitution, English statutes had long empowered nonjudicial bankruptcy ‘commissioners’ to collect a debtor’s property, resolve claims by creditors, order the distribution of assets in the estate, and ultimately discharge the debts. This historical practice, combined with Congress’s constitutional authority to enact bankruptcy laws, confirms that Congress may assign to non-Article III courts adjudications involving ‘the restructuring of debtor-creditor relations, which is at the core of the federal bankruptcy power.’”

This approach has also been suggested in a separate opinion by Justice Thomas, who was part of the Court’s majority in Stern:

“Congress . . . has assigned the adjudication of certain bankruptcy disputes to non-Article III actors since as early as 1800. . . Bankruptcy courts clearly do not qualify as territorial courts or courts-martial, but they are not an easy fit in the “public rights” category, either. . . We have nevertheless implicitly recognized that the claims allowance process may proceed in a bankruptcy court, as can any matter that would necessarily be resolved by that process, even one that affects core private rights. . . . For this reason, bankruptcy courts . . . more likely enjoy a unique, textually based exception, much like territorial courts and courts-martial do. . .  That is, Article I’s Bankruptcy Clause serves to carve cases and controversies traditionally subject to resolution by bankruptcy commissioners out of Article III, giving Congress the discretion, within those historical boundaries, to provide for their resolution outside of Article III courts.”

The Supreme Court has attempted for many years to force bankruptcy courts to fit within the permissible parameters for courts created under Article I – territorial courts, military tribunals, and courts created to hear cases involving public rights – but that effort appears to have run its course and has led to uncertainty and confusion. Judge Jordan’s opinion indicates that the Third Circuit believes that the Supreme Court is in the process of abandoning its efforts to apply “public rights” jurisprudence to the specialized system of bankruptcy courts created by Congress, and is on course instead to recognize such courts as a fourth category of exception to Article III courts.

Millennium is now binding precedent in the Third Circuit. It will likely be interpreted broadly by the judges in the District of Delaware, one of the most influential bankruptcy districts in the country, and be viewed as persuasive authority by judges elsewhere. With a plethora of “private rights” litigation in bankruptcy cases on the immediate horizon, the reasoning of Millennium, if ultimately adopted by the Supreme Court, will place bankruptcy courts’ ability to make final rulings in such matters on firmer constitutional footing, and end much of the uncertainty and needless litigation over bankruptcy judges’ authority.