Cases

In re FBI Wind Down Inc., 741 Fed.Appx. 104 (3rd Cir. 2018) – arbitration agreement in
court-approved postpetition asset purchase agreement not applicable (Jennifer Cree)

Relevant Code provisions: § 363(b)

Summary:

The bankruptcy court (Sontchi) approved the chapter 11 debtor’s sale of assets for $280 million
under bankruptcy code section 363(b). The asset purchase agreement for post-closing
adjustments to the purchase price, based on reconciliations of “cash and cash equivalents” and
“accounts payable obligations.” Prior to the entry of the Sale Order, the parties amended the
APA to provide that “disputed items” were to be submitted to arbitration by an accounting firm if
the debtor and the buyer could not agree on the adjustments. In the Sale Order, the bankruptcy
court retained jurisdiction to interpret its order and to determine claims relating to the agreement.
The debtor was unable to resolve post-closing adjustments with the buyer, and initiated an
adversary proceeding in bankruptcy court to resolve the disputes. The debtor contended that
what constituted “cash and cash equivalents” and “accounts payable obligations” was a matter of
contract interpretation, and thus that the dispute fell within the retained jurisdiction of the
bankruptcy court to interpret the order. The purchaser argued that the definition of those terms
was a “disputed item” and thus fell within the arbitration clause. The bankruptcy court ruled for
the debtor, and the district court affirmed. The purchaser appealed to the Third Circuit.
Judge Fuentes reviewed the district court’s order de novo and affirmed it in a nonprecedential
opinion. Upon review of the plain language of the arbitration provision, the court found that the
agreement required arbitration of “disputed items” but not of “disputes.” The Court further noted
the Bankruptcy Court’s determination that “disputed items” was an accounting term of art that
did not extend to issues of contract interpretation. The court found that “disputed items,” as
defined in the arbitration clause, excluded “threshold matters of contract interpretation, which
may be resolved by the courts in the first instance.”
The Third Circuit did not bar parties from agreeing to arbitrate contract interpretation issues
arising under a postpetition asset purchase agreement in a bankruptcy case. “We only conclude
that the parties here have not done so.”

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In re IMMC Corp., 909 F.3d 589 (3d Cir. 2018) – bankruptcy court does not authority to
transfer suit which it lacks jurisdiction to hear (Zachary J. Schnapp)

Relevant Statutory provisions: 28 U.S.C. §§ 451, 610, 1631

Summary:

In 2008, IMMC Corp filed a chapter 11 petition in the Delaware bankruptcy court. In 2010, the
liquidating trustee filed an adversary proceeding, alleging that IMMC’s former officers and
directors breached their fiduciary duties by pursing a risky and expensive litigation strategy in an
unrelated suit against a competitor, and that the officers and directors overcompensated
themselves in the process.

In 2011, the bankruptcy court held that it lacked jurisdiction to hear the claims asserted in the
adversary proceeding because it was neither a “core proceeding” nor a non-core proceeding
“related to” the chapter 11 plan. The trustee did not appeal, but requested the bankruptcy court
transfer the adversary proceeding to the district court for the Eastern District of Pennsylvania
under 28 U.S.C. § 1631. That section refers to § 610, which does not consider a bankruptcy
court a “court” under Title 28. The bankruptcy court denied the trustee’s motion to transfer, and
instead allowed him to file a motion to withdraw the reference in the district court. The district
court denied the motion because the matter was never properly referred to the bankruptcy court.

In 2015, the trustee renewed its motion in bankruptcy court to transfer the adversary proceeding
to the district court under § 1631. The bankruptcy court denied the renewed motion. The trustee
filed a notice of appeal of the bankruptcy court’s denial of the original 2012 motion to transfer
and the renewed 2015 motion to transfer. The district court affirmed both orders. The trustee
then filed an appeal with the Third Circuit.

The issue on appeal was whether a bankruptcy court is a “court” under § 610 even if the statute
does not expressly say so. The language of § 610 closely mirrors that of § 451, cases under
which have held that the bankruptcy court is a “unit” of the district court, even though § 451
does not expressly say so. The trustee based his argument on In re Schaefer Salt Recovery, 542
F.3d 90 (3d Cir. 2008).

The Third Circuit reasoned that a comparison of § 610 to § 451 does not work because, in
Schaefer, the bankruptcy court had jurisdiction over the bankruptcy petition, whereas in IMMCC
it did not.

The Third Circuit held that, even if § 1631 is broad enough to permit transfer between any two
federal courts, because the bankruptcy court could not transfer the proceeding because it lacked
jurisdiction over this adversary proceeding.

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In re Revel AC Inc., 909 F.3d 597 (3rd Cir. 2018) – Non-Debtor Tenant’s Recoupment Rights
on Debtor-Landlord’s Rejection (Shella Borovinskaya)

Relevant Code provisions: § 365(h)

Summary:

The debtor-landlord rejected a prepetition commercial lease under which the tenant operated
clubs in the Revel casino in Atlantic City, N.J. After the debtor-landlord rejected the lease, the
non-debtor tenant elected to remain in possession and retain its other rights under section. 365(h)
for the remaining term of the lease, including regarding the amount and timing of payment for
the rent.

The issue before the Third Circuit was whether the tenant could reduce its outstanding rental
obligations under the lease by recouping amounts payable on certain conditions by the landlord
to the tenant under the lease.

Judge described the lease as “an almost impenetrable web of formulas, defined terms, and cross-
references – a bloated morass.” The tenant was obligated, among other things, to spend $16
million in constructing its nightclubs in the leased premises. As per the terms of the lease, if a
nightclub or beach club venue leased by the tenant did not reach a certain threshold in gross sales
or didn’t have a positive return net of depreciation, the tenant had certain recoupment rights
whereby the landlord would refund to the tenant the amount necessary to cause the tenant to
break even.

Section 365(h) allows the tenant to offset the “value of any damage caused by the [debtor’s]
nonperformance” against the “rent reserved” under the lease.

Judge Ambro ruled that there was “no question” that the tenant’s rental obligations and
recoupment rights arose from the same transaction, and there was “no doubt” that the
recoupment provisions were among the rental terms that remained enforceable after rejection
under Section 365(h)(1)(A)(ii):

To render the “recoupment” component of this framework inoperative, while still

calculating the “rent” component using the same formulas, would upend the rent
framework established in the Lease and deny [the tenant’s] statutory right to
remain in possession of the premises under the same “rental terms.” Accordingly,
by virtue of its election under § 365(h), [the tenant] is permitted to reduce its rent
obligations by the recoupment amounts applicable under the Lease for the balance
of the term of the Lease after the date of rejection ….

It further would be inequitable to require the tenant to pay rent without being entitled to offset
pursuant to the recoupment provision. Thus, pursuant to the doctrine of equitable recoupment
and the tenant’s rights on the debtor-landlord’s lease rejection under § 365(h), the tenant could
reduce its rental obligations by the recoupment amounts.

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The Third Circuit affirmed, holding that the tenant could reduce its rental obligations by the
recoupment amounts provided under the lease.

In re La Paloma Generating Company, LLC, 588 B.R. 695 (Bankr. D. Del.) (Alexander
Faris)

Relevant Code provisions: §§ 106 and 505(c) – State Sovereign Immunity

Summary:

Prepetition, the debtor commenced proceedings for tax refunds before the California State Board
of Equalization asserting that the assessments against its property were too high. After the
debtor’s plan was confirmed, the creditors’ trust filed suit in the bankruptcy court seeking a
reduction in the amount of the assessments and refunds based on the lower assessments. The
Board of Equalization contended that it had sovereign immunity from the suit. The bankruptcy
court (Sontchi) agreed and dismissed the suit.

Code section 505(a) authorizes a bankruptcy court to “determine the amount or legality of any
tax, . . . whether or not previously assessed, whether or not paid, and whether or not contested
before and adjudicated by a judicial or administrative tribunal of competent jurisdiction.”

Section 106(a)(1) abrogates state and municipal sovereign immunity with respect to section 505.
The issue with section 106, though, is the extent to which it stands under the 11 th Amendment of
the Constitution. The Third Circuit has applied the Supreme Court’s Seminole Tribe case to hold
that section 106(a) is “unconstitutional to the extent that it purports to abrogate state sovereign
immunity in federal court.” Sacred Heart Hospital v. Dept. of Public Welfare (In re Sacred
Heart Hospital), 133 F.3d 237, 245 (3d Cir. 1998).

But the Supreme Court has restricted the reach of Seminole Tribe in bankruptcy cases. In
particular, the Court held in Central Valley Community College v. Katz, 546 U.S. 356 (2006),
that the bankruptcy court’s authority to avoid a preferential transfer was a core aspect of a
bankruptcy proceeding at the time of the ratification of the Constitution. Thus, the states
consented to such suits when they ratified a Constitution that gave Congress the authority to
enact uniform laws regarding bankruptcies in the United States.

The court, nonetheless, considered itself bound by the Third Circuit’s decision in Sacred Heart
to defer to California’s sovereign immunity. Even if the states by ratifying the Constitution had
waived their sovereign immunity with respect to a preference action, they had not done so with
respect to every contested matter or adversary proceeding in a bankruptcy case. “[M]erely
because the estate may have a claim for a tax refund is not enough to invoke the in
rem jurisdiction of the bankruptcy court.” The tax proceeding did not implicate the court’s in
rem jurisdiction with respect to taxes already paid, including because a ruling on the value of the
debtor’s property against which the taxes had been assessed did not affect any rights in the
property.

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The debtor’s action was “nothing more than a state law claim for a sum of money. To disallow a
sovereign immunity defense in this situation would . . . allow a wholesale suit for money
damages.”

The bankruptcy court noted that, once California determined the assessments, it had no immunity
from a proceeding seeking the payment of tax refunds based on those assessments. The court
further noted that it had jurisdiction to determine assessments with respect to which the taxes had
not been paid, because in such case the state’s tax claim would be against estate property.

In re Energy Future Holdings Corp., 904 F.3rd 298 (3rd Cir. 2018) – Court-approved $275
million breakup fee subsequently disapproved (Bruce Grohsgal)

Relevant Code and Rule provisions: § 503 and Rules 9023 and 9024

Summary:

The bankruptcy court (Sontchi) approved a $275 million breakup fee in connection with a
merger of the debtors with an initial purchaser. The breakup fee was payable if the debtors
terminated the agreement. Conflicting statements were made at the hearing, regarding the
grounds on which payment of the breakup fee would be excused if the merger agreement was
terminated because state regulators refused to approve the transaction.

The state regulators disapproved the merger in April 2017, by which time the merger was
“clearly dead” in the bankruptcy court’s view. The initial purchaser appealed the regulators’
disapproval, though, rather than terminating. In the bankruptcy court’s opinion, the initial
purchaser made it clear that it would appeal the regulators’ disapproval “to all levels of review,
leaving the Debtors no choice but to terminate the Merger Agreement and risk triggering the
Termination Fee or else incur months or years of continued interest and fee obligations.”

In early July, the debtors formally terminated the merger agreement. Later that month, creditors
filed a motion for reconsideration of the bankruptcy court’s approval of the breakup fee. The
bankruptcy court granted the creditors’ motion, and revoked its grant of the breakup fee,
including because the merger agreement did not set forth an outside date for approval by the state
regulators and the court was never informed that the initial purchaser “would never be required
to terminate” and instead “could simply wait for mounting financial pressure” to force the
debtors to terminate, thereby triggering payment of the breakup fee.

The Third Circuit accepted a direct appeal from the initial purchaser.

Judge Greenaway affirmed the bankruptcy court’s revocation of the breakup fee because the
judge had “failed to discern a critical fact that profoundly altered the underlying legal
determination.” The Third Circuit held that though there are time limits under Bankruptcy Rule
9024 for reconsideration of a final order, there is “no strict time limit” for reconsideration of an
interlocutory order. The bankruptcy court’s approval of the breakup fee was interlocutory

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because the allocation of the breakup fee among the debtors was left to later determination,
because the bankruptcy court reserved jurisdiction to resolve disputes under the order, and
because of the “flexible, pragmatic approach to finality in the bankruptcy context.” Thus, there
was “no strict time limit” for the creditors to seek reconsideration. The bankruptcy judge,
further, did not abuse his discretion by declining to reconsider based on laches because the
creditors filed their motion shortly after the debtors terminated the merger agreement.

On the merits, the Third Circuit determined that the bankruptcy judge “had a fundamental
misunderstanding of the critical facts,” including that the judge was not told that there was no
time limit within which the initial purchaser was required to obtain regulatory approval.

In the Third Circuit’s view, the bankruptcy court’s misunderstanding of the facts resulted in its
failing to weigh the potential harm to the estates against the potential benefits of its approving
the breakup fee. Based on this error, the bankruptcy court improperly weighed the factors
required for approval of a breakup fee, and did not abuse its discretion when it revoked its
approval of it.

Judge Rendell dissented, urging that there “was no legal or factual error” and that
reconsideration “based on a bankruptcy court’s failure to appreciate all of the potential
ramifications of the terms sets a troubling — if not dangerous — precedent.”

Quizzo

FBI Wind Down

1. What did the court in FBI Wind Down primarily rely on when it interpreted an arbitration
clause contained in sale documents: A) the Bankruptcy Code; B) the Bankruptcy Rules;
C) contract language; D) the Delaware Local Rules.

2. True/False:  The Third Circuit has barred parties from mutually agreeing to submit issues
of contract interpretation to arbitration.

IMMCC

3. True/False: The Third Circuit in IMMCC held that a trustee’s motion under 28 U.S.C. §
1631 to transfer an adversary proceeding over which it has jurisdiction to a district court
should be denied because under § 610 a bankruptcy court is not a “court.”

4. True/False: The Third Circuit in IMMCC held that, if a bankruptcy court does not have
jurisdiction over an adversary proceeding, it must transfer the proceeding to a district
court.

Revel

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 5. Which bankruptcy policy is furthered by Code §365(h)? Is it A) a fresh start, B) orderly
distributions to creditors and other parties, C) preserving businesses as going concerns,
D) maximizing value and distributions, or D) none of the above?

6. True/False: If the bankruptcy court approves the debtor-landlord’s rejection of a

commercial lease, the non-debtor tenant must vacate the leased premises.

La Paloma

7. True/False: In light of the La Paloma decision on sovereign immunity, section 106 does

not abrogate a State’s sovereign immunity with respect to an adversary proceeding to
avoid and recover a preferential transfer made to that state.
 
8. How can a State voluntarily invoke the bankruptcy court’s jurisdiction and waive the
State’s sovereign immunity? A) by filing a claim with the bankruptcy court, B) by
becoming a party to a cause of action, C) by successfully seeking removal of state court
actions to federal court, or D) all the above.

Energy Futures

9. True/False: The Third Circuit in Energy Futures held that a motion for reconsideration
of an interlocutory order must be filed within one year.

10. The standard for approval of a breakup fee in the Third Circuit is: A) whether the fee is a
reasonable use of estate property under Code § 363, B) the proper exercise of the debtor’s
business judgment, C) whether the fee is an actual and necessary expense under Code
§ 503, or D) whether the fee is between 3% and 5%, subject to an extraordinary
circumstance exception