Developments Relating to Third Party Releases in Chapter 11 Bankruptcies

The bankruptcy matter In re Millennuium Lab Holdings II, LLC, et al. (District of Delaware Case No. 15-12284-LSS) recently resulted in some non-binding guidance on a growing issue in chapter 11 bankruptcy cases - third party releases.

Background

Chapter 11 plans tend to include third party releases that, once the debtor’s creditor is paid in accordance with the plan, will trigger the satisfaction of the obligation of another affiliate (which could also include directors and officers) who shares liability for that debt. Sometimes these releases are non-consensual, meaning that the creditor is bound by the release, regardless of its potential opposition, as long as the plan is confirmed.  These releases are a continuously growing source of tension in chapter 11 cases as their inclusion in plan confirmation orders is often contested. This leaves the Bankruptcy Court in the position of balancing their broad authority under § 105(a) of the Bankruptcy Code, which allows for the issuance of any order that is appropriate or necessary to carry out the provisions of the Bankruptcy Code, and other sections that indicate a lack of authority on the part of the Bankruptcy Court to order a non-consensual third party release.

The Millennium Case

Millennium Lab Holdings ultimately confirmed its chapter 11 plan and the confirmation order included non-consensual third party releases. Several lenders with claims subject to the releases appealed and initiated the District Court action Opt-Out Lenders v. Millennium Lab Holdings II, LLC, et al. (District of Delaware Civ. No. 16-110-LPS). After briefing, the District Court issued an opinion on March 17, 2017. In the opinion, the District Court expressed severe doubt regarding bankruptcy confirmation orders containing non-consensual third-party releases. While the matter was ultimately remanded for a decision by the Bankruptcy Court, the opinion includes a section where the District Court stated that constitutional authority for the Bankruptcy Court to order a non-consensual third-party release is unclear and came close to dismissing even the potential for de novo review of such an order for the purpose of adequately protecting the rights of the parties.

In Conclusion

The District Court’s opinion is another step away from the leniency that officers, co-borrowers, and guarantors seeking third party releases in an affiliate’s bankruptcy have benefitted from in the past. The immediate result is greater uncertainty with respect to potential releases and, based on the District Court’s analysis, the long-term result may be that plan proponents will have a much harder time approving non-consensual third party releases during the plan confirmation process.

In the News: Filip Technologies, Inc. Plan Confirmed

Law360 was in the courtroom on Thursday covering the confirmation hearing in the Filip Technologies, Inc. chapter 11 case, which is a current client of our firm that developed technology for parents to track the location of their young children. Judge Gross was pleased with the 100% creditor support that David Klauder and the other attorneys from Bielli & Klauder, Moore & Van Allen PLLC, and creditor AT&T Capital Services Inc. were able to generate for the plan, which was ultimately confirmed after the resolution of an objection by one of the Debtor’s retained professionals.

The full article featuring Dave is available at https://www.law360.com/articles/880342?ta_id=610758&utm_source=targeted-alerts&utm_medium=email&utm_campaign=case-article-alert.

Seizure/Garnishment of Government Benefits

While the reasons that motivate a person to file for bankruptcy vary widely, one of the most common is to protect an asset. Depending on the nature of the asset, unpaid creditors may try to access it through either garnishment or seizure. Cash assets, including wages that will be paid and bank accounts, can be taken by creditors through garnishment. However, the source of the cash asset can actually serve to protect it, like if it comes in the form of Social Security benefits.

Anyone who receives Social Security benefits is typically not subject to having those benefits seized. However, this protection is not absolute. Certain debts owed to the Federal government may result in garnishment by specific governmental entities, such as the IRS. Also, delinquent child support or alimony can allow for the garnishment of Social Security benefits. While these types of creditors may be a threat to someone relying on Social Security, most other creditors will have no access to identifiable Social Security benefits. This means that garnishment by credit card companies, by collection agencies, or for most medical bills is impossible if an individual’s only income comes from Social Security and they have no substantial assets.

In Conclusion

Bankruptcy serves as a way for people with overwhelming debt to obtain a “cooling off period” and a “fresh start”. However, anyone considering filing for bankruptcy only as a means to protect their Social Security income needs to consider that their benefits may be safer than they originally thought.

Fraudulent Transfers

Throughout the bankruptcy process, the financial activity of the debtor will be subject to examination by the trustee and by creditors. In most cases, the examination consists of the trustee reading though the documents filed by the debtor and asking questions at a relatively short and informal meeting. However, certain activity during the ‘look back period’ will draw the attention of the trustee and potentially the creditors. One such activity is a fraudulent transfer, which is where someone transfers property in a manner that hinders, delays, or denies a creditor.

The problem with fraudulent transfers is that some people do not know that they are making them. For example, selling a relative some property at below the market value of the property is common and considered a favor or a gift. But, in the eyes of the trustee or a creditor, the full value of that property should have belonged to the bankruptcy estate, which the creditors ultimately divide and share.

Having to deal with potential fraudulent transfers will add some complications to the bankruptcy process, likely leading to valuations and potentially liability for the individual who the debtor transferred the property to. While the first thought of a debtor may be to avoid disclosing the pre-petition transfer of property, the penalties for fraud during the bankruptcy process can range from non-dischargeability to jail time - so full and complete disclosure is not only the best option, it is the only option.

In Conclusion

Any potentially fraudulent transfer must be disclosed to the debtor’s attorney and to the trustee. While there may be an impact on the debtor or the recipient of the transfer as a result of this disclosure, a capable attorney can maximize the debtor’s exemptions in order to minimize any liability.

Non-Dischargeable Debts

Chapter 7 is the most common type of bankruptcy that an individual will enter into. Chapter 7 bankruptcies also come the closest to matching the concept of bankruptcy that most people who have never gone through the process have. In a chapter 7, an individual surrenders their assets (minus certain assets that can, by statute, be exempted) in exchange for the discharge of their debts. After their discharge, the debtor is free from the obligations that they owed before filing. However certain debts survive bankruptcy, which are labeled as ‘non-dischargeable.’
Some of the most common non-dischargeable debts are certain taxes. Whether they are owed to a municipality, the IRS, or a different entity, the government wants to get paid and assured that the Bankruptcy Code was written in a way that would allow it to collect.

Student loans are also generally non-dischargeable. The fact that they are so common in many young individuals’ lives (and because a high incomes typically are not) earned student loans their own exception from discharge.

Another category of common and non-dischargeable debt is domestic support obligations. These debts earned special treatment based on the idea that bankruptcy should not be used as a way to circumvent the provision of critical income that someone relies on to survive.

In Conclusion
Despite the idea that bankruptcy is the solution to debt, some types of debt, not limited to those listed above, will survive a bankruptcy discharge. While it is important to remember that some debts cannot be discharged, it is also important to remember that almost any party that is owed a debt by someone who is in a financial situation where bankruptcy is the only option should be willing to consider settling or modifying the debt in a way where the best interests of the debtor and the creditor can align.

The Automatic Stay

Filing for bankruptcy can provide a number of major benefits to someone in a difficult financial situation. For people who are suffering from bothersome debt collection calls or a looming foreclosure action, one of the most appreciated of these benefits is the Automatic Stay.

The Benefits and When They Apply

The Automatic Stay serves a kind of shield against most collection efforts. It goes into effect immediately upon the filing of the voluntary petition and the other documents that are necessary to initiate a bankruptcy case. Filing these documents with the Bankruptcy Court results in them being stamped with the date and time of filing, meaning that the Automatic Stay goes into place at that exact moment. All of the filer’s creditors are subject to the Automatic Stay at that point, regardless of whether they received notice of the filing. If anything that is barred by the Automatic Stay happens even a minute after the filing, it will be either void or voidable.

The practical impact of the Automatic Stay is that most creditors’ efforts against the filer are put on hold without a hearing or even notice from the court. The Automatic Stay will block collection attempts (including phone calls), certain judicial proceedings, and actions to create, perfect, or enforce a lien against the filer’s property. This can be critical in the event of a foreclosure or sheriff sale. Filing for bankruptcy will place these events on hold, which can give the filer additional time to find an alternate place of residence or to attempt to save the property. In the case of an eviction from a lease, the Automatic Stay applies unless the landlord already has a Judgment for Possession.

One of the most important aspects of the Automatic Stay is the relief that it provides. Desperate financial situations involve stress that can seem to be coming from every angle. After the Automatic Stay goes into effect, filers can answer their phones without worrying who is calling, utility companies will be forced to continue service, and eviction or foreclosure proceeding slow down enough so that the filer can take time to focus on transiting or preserving their residence.

The Limitations

The Automatic Stay has a dramatic effect on the people who file bankruptcy and their creditors. However, it does not apply in every situation or to every debt. For those who have filed multiple bankruptcies in the past year, the Automatic Stay will be reduced to a shorter period or may not apply at all. The Automatic Stay also does not apply to certain Family Court matters, certain tax proceedings, or to the great majority of criminal proceedings. Whether the stay applies in one particular set of circumstances is a question that should be asked of an experienced bankruptcy attorney.

Another limitation of the Automatic Stay is that it is not absolute. Under certain circumstances, a creditor can petition the court for relief from the stay. If the creditor succeeds, they will be free to collect on the debt they are owed just as if the bankruptcy filing never happened. Whether or not a potential filer should be concerned about a creditor seeking relief from the stay is, again, a question for an experienced bankruptcy attorney.

In Conclusion

The Automatic Stay creates the potential for immediate relief from the majority of creditor actions. While there are exceptions that may apply, the Automatic Stay generally provides, at a minimum, some time for the filer to get organized or to attempt to resolve the issue. Its immediate nature means that last minute bankruptcy filings can be an effective option in some of the most desperate situations. Receiving and especially preserving the Automatic Stay can be difficult, especially under certain circumstances, so engaging the right bankruptcy attorney is always advisable.