Benchnotes Apr 2002

In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Autostyle Plastics Inc.,</i> 269 F.3d 726 (6th Cir. 2001)</a>,
insiders had acquired a participation interest in the lead lender's credit facility. A
subordinate creditor challenged the right of the insiders to share the first priority
status, asserting four legal theories. Initially the subordinate lender claimed that
the participation agreement itself was invalid. The court noted that a participation
agreement is not a loan, but rather a contractual obligation between a lender and a
third party where the third party—the participant—provides funds to the lender. As
such, the parties to the participation agreement may choose whatever terms they wish,
and the agreement will generally be enforced as to its terms. Relying on <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re
Coronet Co.,</i> 142 B.R. 78 (Bankr. S.D.N.Y. 1992)</a>, the court held
that there is a four-part definition of a "true" participation agreement: (1) the
money is advanced by a participant to a lead lender; (2) the participant's right
to repayment only arises when the lead lender is paid; (3) only the lead lender
can seek legal recourse against the borrower; and (4) the document is evidence of
the parties' true intentions. After finding that the participation agreement in question
met this definition and was legal and enforceable, the court then rejected the argument
that the participants were required to file notices pursuant to §9-402 of the
UCC, noting that the UCC does not require participants to obtain separate security
agreements or to file separate financing statements, nor does it require the lead
lenders financing statement to identify participants. The court then addressed the
argument that pursuant to §510(c), the insiders alleged that inequitable conduct
required equitable subordination. The court addressed the traditional three-prong argument
found in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… Steel Co.,</i> 563 F.2d 692 (5th Cir. 1977)</a>: (1)
the claimant must have engaged in some type of inequitable conduct; (2) the
misconduct must have resulted in injury to the creditors of the bankrupt or conferred
an unfair advantage on the claimant; and (3) equitable subordination of the claim
must not be inconsistent with the provisions of the Bankruptcy Code. The court noted
that satisfaction of the three-part standard does not mean that a court is "required"
to equitably subordinate, but rather the court is permitted to take such action. There
were three arguments represented in support of the alleged inequitable conduct: (1)
that the participations were actually disguised as bridge loans, which the court
rejected as "baseless;" (2) that there was lack of notice to the junior lender,
which also failed because the junior lender was clearly aware of the senior lenders
and had to challenge the senior lender's loan; and (3) that the debtor was
under-capitalized. Noting that the fact that the debtor was undercapitalized would not
"by itself" be enough to allow the party to prevail on a claim of equitable
subordination, the court found that there was no evidence of any activity beyond
initial undercapitalization that would support a claim for subordination. Thus, absent
such additional evidence, the challenge must also fail. Finally, the subordinate
lender argued that the alleged debt should be recharacterized as equity. The court
examined the factors set forth in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… Steel Tube Co. v. Comm'r. of Internal
Revenue,</i> 800 F.2d 625 (6th Cir. 1986)</a>: (1) the names given to
the instruments, if any, evidencing the indebtedness; (2) the presence or absence
of a fixed maturity date and schedule of payments; (3) the presence or absence of
a fixed rate of interest and interest payments; (4) the source of repayments;
(5) the adequacy or inadequacy of capitalization; (6) the identity of interest
between the creditor and stockholder; (7) the security for the advances; (8) the
corporation's ability to obtain outside financing; (9) the extent to which advances
were subordinated to claims of outside creditors; (10) the extent to which advances
were used to acquire capital assets; and (11) the presence or absence of a sinking
fund to provide repayments. The court found that the lender was unsuccessful in
establishing these factors sufficient to result in recharacterization of the debt. As
a result, the insiders were allowed to assert a secured claim under the participation
agreement senior to that of the subordinate lender.

</p><h3>Surcharge Claims for Administrative Claimants</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Suntastic USA Inc.,</i> 269 B.R. 846 (Bankr. D. Ariz.
2001)</a>, Bankruptcy Judge <b>Charles G. Case II</b> addressed circumstances under
which a chapter 7 trustee could be arguably compelled to pursue surcharge claims on
behalf of specific administrative claimants. Relying on <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re JKJ Chevrolet Inc.,</i>
26 F.3d 481 (4th Cir. 1994)</a>, the court noted that the trustee owes
a fiduciary duty to the creditors of the estate. Judge Case concluded that the test
of whether a trustee may refuse to pursue a §506(c) claim after request by
administrative claimant is whether doing so may conceivably benefit the estate, without
regard to whether the action will benefit the requesting claimant. Examples of such
circumstances could include situations where a payment of a legitimate surcharge claim
from the secured creditor's collateral would increase the pool of unencumbered assets
remaining to pay other administrative or perhaps even unsecured creditors that do not
have a legitimate basis on which to seek a surcharge. In such event, the net result
would be an increase in the pro rata distribution available to other creditors—clearly
a benefit to the estate. However, under these facts, there were no unencumbered
funds, and the only basis for payment of the administrative claimants is whether they
can individually establish entitlement to a surcharge. Whether they do or do not has
no impact on the estate as a whole or on other creditors. Thus, the court held that
it is not part of the trustee's mandatory exercise of a fiduciary obligation to take
action, the end result of which can only benefit an individual creditor or claimant.

</p><h3>Right of Recoupment Not "Claim"</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Abco Industries Inc.,</i> 270 B.R. 58 (Bankr. N.D. Tex.
2001)</a>, Bankruptcy Judge <b>Robert C. McGuire</b> addressed and distinguished setoff vs.
recoupment in the context where the claimant had actually filed a proof of claim,
which was eventually disallowed. Although the defensive use of setoff (or recoupment)
is not necessarily precluded by the failure to file a proof of claim, the court held
that setoff is not to be permitted if the claim that is sought to be used as a
setoff is actually disallowed. However, as the equitable right of recoupment is not
addressed in the Code or subject to the restrictions found in §553 relating to
setoff, "it is not a right specifically part of a claims allowance or disallowance
process." Thus, the court held that a right to assert recoupment was not lost when
a claim is disallowed and is not precluded from being raised as a defense. In
addition, the court noted that the right of recoupment is not a "claim" in bankruptcy
because it does not give rise to a right to actual payment, it merely reduces a debt
and thus is a defense and not a renewed claim.

</p><h3>Miscellaneous</h3>

<ul>
<li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Lamarre,</i> 269 B.R. 266 (Bankr. D. Mass. 2001)</a> ("unmatured interest" is not to be equated with interest that is contingent, disputed
or unliquidated");

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Golden Books Family Entertainment Inc.,</i> 269 B.R. 300
(Bankr. D. Del. 2001)</a> (non-exclusive licensing agreement could not be assumed
and assigned by the trustee of the debtor/licensor without the licensor's consent);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Golden Books Family Entertainment Inc.,</i> 269 B.R. 311
(Bankr. D. Del. 2001)</a> (under federal copyright law, exclusive licensees have
the right to freely assign their rights without the need for first obtaining licensor's
consent);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Dunning,</i> 269 B.R. 357 (Bankr. N.D. Ohio 2001)</a> (order
awarding punitive damages for violation of the automatic stay for post-petition
setoff);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Grau,</i> 267 B.R. 896 (Bankr. S.D. Fla. 2001)</a> (court
can approve a settlement agreement relating to a claim of exemptions over the objection
of a creditor who has filed a separate exception to exemptions, and such a settlement
would bind such objecting creditor);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Miranda,</i> 269 B.R. 737 (Bankr. S.D. Tex. 2001)</a> (the
bankruptcy court has no authority to extend the deadline for filing a proof of claim
in a chapter 13 even if there are no objections);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re J.E. Adams Industries Ltd.,</i> 269 B.R. 808 (N.D. Iowa
2001)</a> (post-petition notification letters relating to payment dates and cancellation
of insurance policy for non-payment is not a violation of the automatic stay);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Nuclear Imaging Systems Inc.,</i> 270 B.R. 365 (Bankr. E.D.
Pa. 2001)</a> (consensual carveout for the benefit of debtor's counsel did not create
"property of the estate" subject to claims of the chapter 7 trustee, but was property
of the creditor that, but for its consent, would have been distributed to the
creditor); and

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&amp;vr=1.0&amp;cite=… re Weinstein,</i> 272 F.3d 39 (1st Cir. 2001)</a> (post-petition
interest on post-petition tax debt was entitled to first priority as administrative
expense of chapter 7 estate).

</li>