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The dissolution of a law firm can be a financial catastrophe for its partners. In a typical law firm dissolution, the partners lose any bonuses, end-of-year draws, and thousands or hundreds of thousands of dollars in capital. Adding insult to injury, if the firm’s creditors force it into bankruptcy, which often happens following law firm dissolutions, the partners can expect to be the targets of litigation.
[1]Over the last 30 years, dozens of notable U.S. law firms have dissolved or gone bankrupt. Although many of those firms were relatively small, others were among our country’s largest and most venerated.[2]
A law firm’s demise is often years in the making. But once circumstances become dire, a law firm’s collapse can happen swiftly. Sensing the end, equity partners, contract partners and laterals may leave individually or in groups, taking the most profitable business with them and accelerating a teetering firm’s death spiral.
Individual debtors have the right to retain and use pre-petition property to reorganize under chapter 11 without first getting creditors’ consent or proposing to pay them off — at least according to the Bankruptcy Code.[1] 11 U.S.C. § 1129(b)(2)(B)(ii) expressly spares individual chapter 11 debtors from the absolute priority rule[2] when they propose in their plans to retain property “included in the estate under § 1115.” Under 11 U.S.C. § 1115(a), “property of t
Editor's Note: Reprinted with permission from the ABI Journal, Vol. XXXIII, No. 9, September 2014.
Partnership law and bankruptcy law are not strangers. Perhaps no greater proof can be found than in the recent battle over the unfinished-business claims of dissolved law firms, which pit a law firm’s bankruptcy estate against the lawyers that often served as the firm’s lifeblood prior to their bankruptcy filing.
[1]As courts continue to work out the finer points of the “plausibility” standard of pleading announced by the Supreme Court in Bell Atlantic Corporation v. Twombly[2] and further developed in Ashcroft v. Iqbal,[3] plaintiffs are well advised to be as specific as possible in alleging facts to support their claims.[4] A recent decision from a Minnesota bankruptcy court emphasizes that this is especially true when it comes to invoking the equitable doctrine of recharacterization as a means of converting debt to equity in a bankruptcy case.[5]
A significant body of literature has developed in the wake of Stern v. Marshall[1] and the evolving roles of the courts. Aside from the incurred costs from dragging a bankruptcy judge’s proposals through the district court for review, the practical significance of mandating these steps depends on the tendency of district courts to adopt the bankruptcy court’s recommendations. However, there is a procedural disconnect with respect to the manner in which some courts carry out their roles that can leave experienced practitioners confused — and pro se litigants in peril.
VWI Properties LLC, the pre-petition purchaser of the secured debt associated with the hotel property owned by Mt. Olive Hospitality LLC (the debtor), filed several objections challenging the validity of certain unsecured claims totaling more than $4 million and the characterization of those claims as debt. VWI further asserted through a motion that the alleged noteholders were insiders of the debtor and thus ineligible to vote on the confirmation of the debtor’s proposed chapter 11 plan.
Recharacterization is a judicial doctrine originating in the case law of most state courts. Its main tenet is that “a spade should be called a spade”; that is, if an extension of credit has more of the characteristics of equity than of debt, it should be treated like equity even if it was denominated as debt. Thus, a loan that looks more like an equity investment will not be permitted to share in distributions to creditors, but will be classed as equity and paid (or not paid) in the same manner as equity.
Your client has been providing products to a customer for years. The client is not paid directly by its customer, but by the customer’s parent company as part of a cash-management system (CMS), what the customer describes as an enterprise-wide pooled account. After a couple of turbulent months with irregular payments, the customer files for bankruptcy. The client asks about its outstanding receivable and preference exposure but there is more at risk than just the last 90-days of payments.
