If you haven’t been involved in a corporate Bankruptcy lately, you may not be following the hottest issues emerging from the Bankruptcy courts. Some of the case law that’s being created right now–and even where there is uncertainty– could be relevant if you become involved in a Bankruptcy case in the future, so take a few minutes to catch up on the top headlines. 

There’s no one better than Sassoon Cymrot’s Rick Levine to explain some of the top issues being debated in bankruptcy courts around the country right now. A Bankruptcy attorney since 1970, Rick is one of the top experts in the field of Bankruptcy law. He was appointed by the Chief Justice of the United States to be a member of the committee that drafted the Federal Rules of Bankruptcy Procedure. The United States Attorney General appointed Rick as the first Director and Counsel of the Executive Office for United States Trustees, the Federal office that supervises the administration of virtually all Bankruptcy cases in the country. He has served as the co-chair of the Boston Bar Association Senior (55+) Lawyers’ and Criminal Law Sections, and for years has co-chaired the BBA Bankruptcy Law Section’s Committee dealing with pending legislation. Rick is also a frequent expert witness on conflict and other ethical matters relating to Bankruptcy and insolvency issues, and has been a Contributing Author to the Collier Bankruptcy Practice Manual.

Bankruptcy Options for Small Businesses Might Be Extended

Rick says that one of the most pressing current issues around corporate restructuring involves simplifying bankruptcy proceedings for smaller organizations. A current provision that helps small businesses qualify for a streamlined version of Chapter 11 is set to expire before the end of this month. 

“Chapter 11s are expensive, they involve creditors’ committees, they involve a lot of trips to court, and they are frequently unsuccessful. So Congress about three years ago decided to add Subchapter V to Chapter 11, which is limited to corporations with debt of less than $2.75 million. The idea was a streamlined Chapter 11. You didn’t have to deal with a creditors’ committee. There might be a trustee, but the trustee had limited power. If things worked well, you could sail through the procedures more quickly, more cheaply, with less angst. And it’s much less expensive than a ‘standard’ Chapter 11 would be.”

While Subchapter V cases were slow at the start, Rick says they’ve started to catch on. It’s an attractive option for distressed businesses that can’t afford the time and costs of a full-blown Chapter 11 case, and don’t want to end their operations by filing for Chapter 7 liquidating Bankruptcy. 

“So, Congress had established the $2.75 million debt cap for Subchapter V. When COVID hit, Congress increased that debt cap to $7.5 million. However, that increase had an expiration date of March 27, 2022. But now professionals are asking why the higher cap should ever expire, and while we’re at it, how about pumping up the cap to $10 million?”

“Chapter 11, even an uncomplicated one, could run up professional fees anywhere from $25,000 into the millions. The National Association of Bankruptcy Trustees has proposed, and the Boston Bar Association is considering supporting that proposal, to increase the debt cap to $10 million and to make Subchapter V permanent.” 

Debate Continues About the Release of Non-Debtor Parties

Another topic that’s being hotly contested in Bankruptcy courts right now involves the release of non-debtors from claims of creditors. Except for businesses in Chapter 7 liquidations, who can’t get a discharge of debt, the Bankruptcy Code generally releases debtors from creditors’ claims. However, nowhere does the Bankruptcy Code provide for releases of non-debtors, such as guarantors of corporate debt, directors, officers, owners, or professionals, even though in some cases these non-debtors may be liable to creditors under other federal law or state law. 

What’s happening now is a hot debate about whether non-debtors should also be entitled to these kinds of releases. Although the Bankruptcy Code does not provide for the release of creditor claims against non-debtors, over the years some courts have permitted Chapter 11 Plans to provide such releases. Different courts have created different tests as to when to permit such releases, and there is not much consistency. Rick cites the ongoing Purdue Pharma case as an example of a case in which non-debtors may come into play. In addition to pursuing the corporation itself for improperly pushing Oxycontin, creditors had also made claims, or threatened to make claims, against Purdue’s directors and owners, citing their involvement in creating the opioid crisis.

“If I’m a mother and my son is a drug addict because Oxycontin was pushed on him by advertisements, or there weren’t the right warnings, then I would have a claim against the company, and perhaps also against the officers and directors—assuming there’s appropriate proof that the officers and directors should be liable. It’s those claims, where a creditor has a claim directly against officers and directors or other entities, that’s what all this is about.”

Rick says there’s tremendous inconsistency in how courts are handling cases involving the release of non-debtors. “There’s a conflict among circuits around the country. Some say you can’t do it at all, some say you can do it if the standard is high. No one knows. So people are hoping the Supreme Court will rule on this. In the Purdue case, the insiders increased the amount of their contribution to the Plan from $4.3 billion to $5.5 billion in order to persuade creditors to accept, and win acceptance by the Court. That effort succeeded, and on March 9, 2022, the Bankruptcy Court indicated it would approve that arrangement. Whether or not the Court of Appeals will validate such a Plan will be the next nail-biter.”

Bad Faith, the “Texas Two-Step” and Divisive Mergers as illustrated by the Johnson & Johnson Case

Multiple hot-button issues around corporate restructuring are playing out right now during the ongoing Johnson & Johnson bankruptcy case. More than 38,000 lawsuits have been filed against the company because its talc baby powder contained asbestos, allegedly causing cancer in thousands of J&J customers. 

“Some states have passed laws oxymoronically authorizing so-called divisive mergers, which is really strange. These laws allow corporations to shed their ‘bad’ assets and related liabilities into a separate entity. So J&J said, ‘we’re going to take the talc division and we’re going to divisively merge. The result of which will be all the claims and all the assets used in manufacturing talc–all of that–will be in a separate company now. And then we’ll file bankruptcy for that company.’ 

“In the normal course of things—if it weren’t for these statutes that some of the states have enacted—it would be easy for the creditors to attack. Because the creditors will say, ‘Wait a minute. You’re a debtor, you owe money. You just transferred assets with the intention of hindering or delaying creditors’ efforts to collect–a classic fraudulent transfer. It would have been a fraudulent transfer 500 years ago when Queen Elizabeth I was around, and when the concept of fraudulent transfers first emerged. 

“But states that have passed such laws are essentially saying, ‘No, there’s no transfer, it’s a divisive merger! It’s this magic creation where fairy dust is sprinkled… and the former division springs into existence as a full-grown corporate entity. And if there’s no transfer, there can’t be a fraudulent transfer. 

“So now these cases show up in the bankruptcy court and arguments take place and people say, wait a minute. This was bad faith. Bad faith has a specific meaning in bankruptcy. It’s not just that you behaved mischievously. Bad faith means basically that you did something you weren’t legally allowed to do. 

“In bankruptcy, debtors can do things like change leases, cancel contracts, all that. So over the years businesses have filed Chapter 11’s not just because they’re restructuring the debt, but because they wanted to take advantage of ancillary provisions of the bankruptcy code. For example, the NRA filed a bankruptcy thinking it would prevent the state of New York from investigating their multiple abuses of their financial obligations under the New York charity laws. The court there ruled that yes, that was bad faith. You didn’t use bankruptcy for its intended purposes. Sometimes companies have filed just to take advantage of the right to terminate leases. You can imagine a whole series of arguments where people say the intention in filing a chapter 11 wasn’t pure enough. 

“This very month, in New Jersey, where the J&J case wound up, the Court has ruled that creating a divisive merger and then filing for ‘BadCo’ is not bad faith, so for now LTL can stay in Bankruptcy and try to negotiate with its creditors.”

Sassoon Cymrot, LLC is proud to have Rick Levine as a resource for our clients with complex needs around bankruptcy and corporate restructuring. Our entire team of bankruptcy attorneys is here to help clients resolve these cases as quickly and painlessly as possible. Don’t hesitate to get in touch with questions. Contact us today.