X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
Typically, at the beginning of every Chapter 11, a debtor must secure financing in order to ensure continued operations. The terms of such financing, particularly when obtained from the debtor’s pre-bankruptcy lender, often conflict with the interests of an unsecured creditor. Normally, a post-petition lender will demand that a broad-based release be given by the debtor with respect to any causes of action that might exist as a result of the pre-bankruptcy relationship between the debtor and the lender. An unsecured creditor, on the other hand, will demand that such causes of action be preserved for prosecution at a later date. This conflict is often resolved, at least temporarily, by the inclusion of a “carve-out” to the debtor’s release and waiver, which grants the official committee of unsecured creditors a limited time to pursue some or all of the causes of action against the pre-petition lender that were otherwise released. What happens to that carve-out, though, if the Chapter 11 fails and is converted to Chapter 7, thereby causing a trustee to be appointed and the committee disbanded? The 10th U.S. Circuit Court of Appeals recently answered that question by holding that a Chapter 7 trustee, appointed after conversion of the debtor’s Chapter 11 case, could not pursue causes of action that were waived by the debtor in the order approving the post-petition financing agreement, despite the fact that the creditors’ committee had been granted the right to pursue such causes of action and such right had not expired at the time of conversion. The case was In re ms55 Inc. The debtor, ms55 Inc. (known under its trade name MSHOW.com), filed Chapter 11 in July 2001. Shortly thereafter, MSHOW filed a motion seeking court authority to enter into a post-petition financing agreement and for authority to use certain of its assets that were subject to the pre-petition lenders’ security interests. The bankruptcy court granted the motion and entered an order that protected the debtor’s pre-petition secured creditors, including Akamai Technologies, from “any and all claims.” Specifically, the order provided that “debtor’s estate � shall be forever barred from asserting any and all claims on any basis or theory against the secured creditors.” The order did include a carve-out that granted the creditors’ committee the right to assert any claim against the secured creditors within a specified time frame. The debtor provided notice of the financing order to its creditors. The notice expressly informed the creditors that the financing order bound parties other than the creditors’ committee and would survive conversion to a case under Chapter 7. The notice further informed creditors that all claims against the secured creditors would be barred, unless the creditors’ committee took action within the deadline set forth in the order, and that this bar would be “binding not only on MSHOW and its creditors, but also on any subsequently appointed bankruptcy trustee.” The debtor’s case remained in Chapter 11 for over a year and a half. During such time, the committee did not assert any claims against the pre-petition lender, but the deadline for doing so did not expire. Subsequently, the parties decided to convert the case to Chapter 7. One of the purposes of conversion was to permit the trustee to investigate and pursue avoidance causes of action. After conversion, the Chapter 7 trustee commenced an avoidance action against Akamai, which then moved for summary judgment on the ground that the claim was barred by the debtor’s release contained in the financing order. The bankruptcy court denied this motion, and Akamai appealed to the district court. The district court reversed, ruling that the financing order barred the trustee’s claim. The trustee appealed the district court’s opinion. The circuit court affirmed the district court’s grant of summary judgment in favor of Akamai. The court first noted that where a debtor in possession in a Chapter 11 waives rights prior to conversion to Chapter 7, the Chapter 7 trustee is bound by the waiver and cannot pursue the released rights. The court rejected the trustee’s argument that because the carve-out of the committee’s right to bring the action precluded a finding of a full release, the estate’s right to pursue the causes of action had not been effectively barred. The court rejected this reasoning, ruling that even if a full release was not made, only the party that was granted the right to pursue the claims � the committee, in this case � had the right to do so. The trustee also argued that it would be unreasonable to interpret the financing order as precluding a Chapter 7 trustee from asserting causes of action against Akamai because the creditors’ committee is automatically dissolved upon conversion. Thus, conversion becomes an “unstated limitation on the creditors’ committee right to bring an avoidance action.” The court disagreed, noting that the notice of the financing order expressly notified the committee that the debtor’s release of claims would be binding on a Chapter 7 trustee. If the committee believed that the debtor’s waiver of certain rights in order to receive the benefit of post-petition financing was unreasonable, it could have objected to the entry of the financing order. Furthermore, the committee could have objected to conversion until it commenced an avoidance action against Akamai. Having failed to convince the court that the financing order’s express waiver of the debtor’s right to pursue the avoidance action against Akamai did not bar him from asserting the claims against Akamai, the trustee next argued that he succeeded to the rights of the committee to bring such action. Akamai countered that the trustee, as the debtor’s successor, could not have inherited rights from the creditors’ committee that the debtor did not have. The trustee argued that the right of a committee to bring an avoidance action is merely derivative of the rights of the debtor and the estate. As the committee retained the right to pursue this derivative cause of action, the avoidance action continued to exist upon conversion. The trustee argued that he, as the representative of the estate, should inherit the existing avoidance action upon dissolution of the committee. The court agreed that the avoidance action itself survived conversion, but it found that the only party with the right to bring such action no longer existed, stating, “The derivative rights exist like a sword in a stone, but there is no Arthur to claim them.” The trustee, as successor to the debtor in possession, is subject to the same defenses as could have been asserted against the debtor in possession, including release and waiver. Had the committee instituted the action prior to conversion, the trustee may have been authorized to continue the action on behalf of the committee. But because the committee failed to do so, the trustee, as the debtor’s successor, was barred from pursuing the claims. It is unlikely that a pre-petition lender will agree to provide post-petition financing, or to allow its pre-petition collateral to be used to obtain post-petition financing from a third party, without the protection of a waiver of claims against it. Bankruptcy courts often approve financing orders with such waivers, but sometimes will not do so over the objection of a committee. In light of the ms55 case, a creditors’ committee should carefully weigh the necessity for post-petition financing against the value of the causes of action being waived by the debtor, and object to the entry of the financing order if the estate would be best served by preserving the causes of action against the lender. At a minimum, a committee should carefully consider objecting to conversion of a Chapter 11 case to Chapter 7 under such circumstances until it has investigated claims against the lenders and commenced any action it believes is viable. Francis J. Lawall , a partner in the Philadelphia office of Pepper Hamilton, concentrates his practice in national bankruptcy and reorganization matters. He routinely lectures to various creditor groups concerning general bankruptcy issues, including preferences, reclamation, the role of creditors’ committees and related issues. Linda J. Casey is an associate resident in the Philadelphia office of Pepper Hamilton. She concentrates her practice in bankruptcy matters.

This content has been archived. It is available exclusively through our partner LexisNexis®.

To view this content, please continue to Lexis Advance®.

Not a Lexis Advance® Subscriber? Subscribe Now

Why am I seeing this?

LexisNexis® is now the exclusive third party online distributor of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® customers will be able to access and use ALM's content by subscribing to the LexisNexis® services via Lexis Advance®. This includes content from the National Law Journal®, The American Lawyer®, Law Technology News®, The New York Law Journal® and Corporate Counsel®, as well as ALM's other newspapers, directories, legal treatises, published and unpublished court opinions, and other sources of legal information.

ALM's content plays a significant role in your work and research, and now through this alliance LexisNexis® will bring you access to an even more comprehensive collection of legal content.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2020 ALM Media Properties, LLC. All Rights Reserved.