Lehman, Rangers, White Energy, Brown, Strauss Auto, Crunch: Bankruptcy

Creditors of Lehman Brothers Holdings Inc. are forming lines of battle for and against the idea of substantively consolidating all of the Lehman companies under a Chapter 11 plan.

In late June, creditors with $15.5 billion in claims against the Lehman holding company filed papers favoring substantive consolidation of the 23 Lehman affiliates. In substantive consolidation, the assets from all Lehman companies would be thrown into one pot and all unsecured creditors would receive the same distribution regardless of the particular company that owed the debt.

Bank of New York Mellon Trust Co. filed papers on July 15 saying that the argument for substantive consolidation is “meritless.” BNY is trustee for holders of $700 million in bond debt that is an obligation of Lehman Brothers Commodity Services Inc. The debt is guaranteed by the Lehman holding company.

Under Lehman’s plan, Lehman Brothers Commodity Services would seem to be making “substantial gifts” to holding company creditors, BNY said. The New York-based bank contends the plan gives “too much value” to holding company creditors “to reward them for substantive consolidation claims” that holding company creditors “cannot possibly win.”

The creditors of the holding company who filed papers favoring substantive consolidation included California Public Employees’ Retirement System, Canyon Capital Advisors LLC, Fortress Credit Opportunities Advisors LLC, Owl Creek Asset Management LP and Paulson & Co.

BNY also disagreed with the motion by the Calpers group to allow creditors to take full-scale discovery about facts related to the plan. Instead, BNY urged the bankruptcy judge to have Lehman “provide meaningful data” by setting up a “data room.” BNY said it wants information so it can make a recommendation to its customers about whether the plan “constitutes a fair compromise,” and pledged not to use the data “for trading or any other purposes.”

Lehman filed a revised Chapter 11 plan in April where creditors of each Lehman company are treated according to the claims against the particular affiliate and its assets. The plan would allow creditors to enforce guarantees where one Lehman company, typically the holding company, guaranteed debt owing by a subsidiary. A creditor with a guarantee therefore could collect twice on the debt, although no more than the amount owed.

In substantive consolidation, as the Calpers group would prefer, guarantee claims aren’t recognized. All assets of all companies are thrown into one pot, and unsecured creditors of all companies are treated the same.

For details on the Lehman plan and disclosure statement, click here and here for the April 15 and April 16 Bloomberg bankruptcy reports.

The Lehman holding company filed under Chapter 11 in New York on Sept. 15, 2008, and sold office buildings and the North American investment-banking business to London-based Barclays Plc one week later. The Lehman brokerage operations went into liquidation on Sept. 19, 2008, in the same court. The brokerage is in the control of a trustee appointed under the Securities Investor Protection Act.

The Lehman holding company Chapter 11 case is In re Lehman Brothers Holdings Inc., 08-13555, while the liquidation proceeding under the Securities Investor Protection Act for the brokerage operation is Securities Investors Protection Corp. v. Lehman Brothers Inc., 08-01420, both in U.S. Bankruptcy Court, Southern District of New York (Manhattan).


Rangers Lenders Attack Deals Just Before Bankruptcy

There will be a hearing tomorrow in the reorganization of the Texas Rangers professional baseball club where the secured lenders and the chief restructuring officer for the team’s owners will ask the judge to reconsider holding an auction on Aug. 4.

The lenders at the end of last week also launched attacks on three transactions the team carried out on the eve of the May 24 bankruptcy filing. The lenders, owed $525 million, contend that the transactions were either in violation of the loan agreements or were fraudulent transfers.

The chief restructuring officer for the team’s owners filed papers on July 15 contending that procedures authorized by the judge last week won’t make for a “fair and commercially reasonable auction” on Aug. 4. The CRO, appointed at the behest of the bankruptcy judge, said the auction rules won’t produce any competing bids.

The CRO said in his papers that the team carried out “what appears to be sizeable and blatantly fraudulent transfers” on the eve of bankruptcy. The CRO was appointed to oversee the team’s partnership owners after they were put into their own Chapter 11 cases involuntarily by the lenders.

The group with the existing contract to buy the team filed papers saying that the motion for rehearing was merely a “rehash” of arguments made unsuccessfully when the judge set up the auction.

The lenders filed three additional sets of paper on July 16. One was a complaint starting a lawsuit in bankruptcy court, alleging that the lease for the ballpark was transferred to the team just before bankruptcy in violation of the loan agreement. The lenders said the effect of the transfer was to put the lease with the team, where the lenders will have a lower recovery than if were there no transfer.

In a second set of papers, the lenders objected to a $5.6 million claim based on a loan that Thomas Hicks, the team’s ultimate owner, made to the team or affiliates before bankruptcy. The lenders said the Hicks loan was in violation of provisions in the loan agreement prohibiting the team from incurring other debt. The lenders protested that the team’s Chapter 11 plan would repay Hicks’ unsecured loan in full when it shouldn’t have been made in the first place.

Finally, the lenders are objecting to $7.5 million in claims by the team’s financial advisers, Merrill Lynch Pierce Fenner & Smith Inc. and Raine Advisors LLC.

The lenders say the obligations to the advisers never were debts of the team until just before bankruptcy. They contend that transferring the liabilities to the team, in connection with a plan that would pay them in full, amounted to fraudulent transfers that bankruptcy can void.

Unless the schedule changes, the first bid at auction on Aug. 4 will be a $306.7 million cash offer from the group that signed a contract just before bankruptcy. The group includes current team President Nolan Ryan and sports lawyer Chuck Greenberg.

The lenders have security interests in the partnerships that own the team. Under the contract signed in May, the lenders would recover $256 million, according to the team’s disclosure statement.

The Rangers moved to Texas from Washington in 1972. The team defaulted on payments owing to the lenders in March 2009. Michael Rochelle, a brother of Bloomberg reporter Bill Rochelle, is a lawyer for an agent for the lenders.

The partnership that owns the team is Texas Rangers Baseball Partners.

The case is In re Texas Rangers Baseball Partners, 10- 43400, U.S. Bankruptcy Court, Northern District of Texas (Fort Worth).

AbitibiBowater Shareholders Want Official Committee

AbitibiBowater Inc., the largest newsprint maker in North America, should have an official committee to represent shareholders, according to papers filed July 16 by a group saying it owns 27 percent of the stock.

The shareholders contend AbitibiBowater isn’t hopelessly insolvent. Their financial adviser says the company’s fair market value is $4.9 billion while the liquidation value is $9.9 billion, according to the court filing.

AbitibiBowater’s value has risen after prices improved for the company’s products, the shareholders argue. A hearing on the motion for an official equity committee will be held on Aug. 4.

The hearing is coming late in the case. The hearing on the disclosure statement explaining the Chapter 11 plan was to have been held July 15. It was adjourned to a date to be determined later.

AbitibiBowater’s existing stock last traded at 9 cents on July 16 in over-the-counter trading.

Aurelius Capital Management LP and Contrarian Capital Management LLC say they have a blocking position to preclude approval of the reorganization plan because they own notes representing more than one-third of unsecured claims against Bowater.

The disclosure statement tells creditors of each of the more than 30 affiliated companies how much they could recover. For details about the plan, click here for the May 25 Bloomberg bankruptcy report.

AbitibiBowater was formed in October 2007 through a merger between Montreal-based Abitibi-Consolidated Inc. and Greenville, South Carolina-based Bowater Inc. Abitibi is a producer of newsprint, uncoated mechanical paper and lumber. Bowater also makes newsprint, along with papers, bleached kraft pulp and lumber.

The Montreal-based company began reorganizing with 24 pulp and paper mills plus 30 wood-product plants. Revenue in 2008 was $6.8 billion. In Chapter 11 petitions filed in April 2009, the combined AbitibiBowater companies listed assets of $9.9 billion and debt totaling $8.8 billion as of September 2008.

The case is AbitibiBowater Inc., 09-11296, U.S. Bankruptcy Court, District of Delaware (Wilmington).

National Envelope Wins Approval for $139 Million Financing

National Envelope Corp., the largest closely held envelope manufacturer in the U.S., filed under Chapter 11 on June 10 and received final approval on July 16 for $139 million in financing. The loan includes the refinancing of pre-bankruptcy debt.

The next major hearing is July 22, when the bankruptcy judge in Delaware is to consider approval of rules for an auction where Gores Group LLC will make the first bid at $134.5 million.

If the judge goes along, other bids will be due initially on Aug. 16, followed by an auction on Aug. 20 and an Aug. 23 hearing for approval of the sale. For other Bloomberg coverage of the financing, click here.

The loan agreement, with General Electric Capital Corp. as agent, required having a sale agreement by July 2 and approval of sale procedures by July 16.

National Envelope, based in Uniondale, New York, has 14 manufacturing plants in 11 states, plus three warehouses. Sales in 2009 were $676 million, resulting in a $44.2 million net loss.

The petition said assets and debt are both less than $500 million. Liabilities include $74.3 million on a secured term loan, $70.6 million on a secured revolving credit, and $89 million owing on unsecured debts to trade suppliers.

The case is In re NEC Holdings Corp., 10-11890, U.S. Bankruptcy Court, District of Delaware (Wilmington).

White Energy Plan Confirmed; Lenders to Get Stock

White Energy Inc., the owner of three ethanol plants, confirmed the reorganization when the bankruptcy judge in Delaware signed an order on July 15 allowing secured creditors to take almost all the new stock.

The plan was mostly negotiated before the Chapter 11 filing in May 2009. In addition to the stock, secured creditors receive a new $150 million secured term loan.

Unsecured creditors, owed more than $19 million according to the disclosure statement, will split up $350,000. Even though secured creditors have deficiency claims of some $50 million, they won’t receive distributions as unsecured creditors.

White Energy filed the plan in December shortly after the bankruptcy judge ended the company’s exclusive right to propose a reorganization. White Energy’s owner, Columbus Nova Ethanol Holdings LLC, filed a competing plan that it later withdrew.

White Energy is one of the 10-largest ethanol producers in the U.S., with plants having a combined capacity of 240 million gallons a year. It is the second-largest gluten maker. Two plants are in Texas with the third in Kansas.

Dallas-based White spent $323 million building the plants in Texas. The principal debt is $294 million owing to secured lenders, the company said when entering Chapter 11.

The case is In re White Energy Holding Co., 09-11601, U.S. Bankruptcy Court, District of Delaware (Wilmington).

Lenders May Credit Bid for Brown Publishing Today

Secured creditors of Brown Publishing Co. can bid their secured debt rather than cash at the auction today, the bankruptcy judge ruled at the end of a July 15 hearing. Brown is the publisher of the largest-circulation local newspaper on eastern Long Island.

The creditors’ committee filed a motion on July 12 petitioning the judge to prevent the lenders from making a so- called credit bid. The motion failed. The judge in substance reaffirmed her previously approved auction rules where credit bidding was permitted.

The motion on credit bidding was part of a two-pronged attack by creditors on the lenders. The committee filed suit on July 14 contending that $72 million in liens given in September 2007 were fraudulent transfers that can be voided in bankruptcy.

The lenders are Prudential Insurance Co. of America, Allied Irish Bank PLC, Brown Brothers Harriman & Co. and Wells Fargo Bank NA.

The hearing for approval of the sale is set for July 22. The banks previously said they intend to credit bid if necessary. A group including Roy Brown, the president and chief executive, is scheduled to make the opening bid of $15.9. Dolan Media Co., publisher of the Long Island Business News, filed papers earlier in the case saying it’s a potential bidder.

Brown publishes Dan’s Papers, the weekly newspaper with the largest circulation on eastern Long Island, New York. It also publishes the Montauk Pioneer.

Based in Cincinnati, closely held Brown listed assets of $94 million against debt totaling $104.6 million. First-lien lenders are owed $70.2 million on a revolving credit and term loan. Second-lien lenders are owed $24.3 million.

Brown has 15 daily, 32 weekly, 11 business and 41 free publications. There are also 51 websites. Seventy-eight of the publications are in Ohio. The business publications are in seven states.

The case is In re Brown Publishing Co., 10-73295, U.S. Bankruptcy Court, Eastern District New York (Central Islip).

Strauss Auto Reorganization Plan Going to Creditors for Vote

Auto parts retailer Strauss Discount Auto scheduled a confirmation hearing for Sept. 1 when it hopes the bankruptcy judge will approve the Chapter 11 plan. The judge signed off on the explanatory disclosure statement last week, allowing creditors to vote.

In its present form, the plan gives creditors all the new stock plus a second-lien note for $8.5 million. Strauss Auto didn’t try to confirm a prior version of the plan even though the bankruptcy judge had approved a disclosure statement.

The plan on which the creditors are now voting is simpler than the predecessor. Unsecured creditors in two classes with approximately $18.7 million in claims are predicted to have a 45 percent recovery by receiving all the new stock plus the $8.5 million note, assuming complete victory in a lawsuit against the company’s former Japanese owner, Autobacs Seven Co.

The suit aims to knock out the former owner’s entire $44 million claim. If the suit fails, the disclosure statement says the recovery by unsecured creditors will be less than 14 percent plus the new stock. Creditors believe the former owner’s claim should be disallowed or subordinated.

The plan needs $10 million in financing. The disclosure statement says there isn’t a loan commitment yet.

The current bankruptcy reorganization is Strauss Auto’s third. The stores are in New York, New Jersey, and Pennsylvania. The new petition in February 2009 listed assets of $75 million against debt totaling $72 million. Debt initially was listed as including $44 million owing to the parent under loan agreements, $9.6 million owing to suppliers, and $12 million in debt owing to landlords and other unsecured creditors.

There were 86 stores and no secured debt when the new Chapter 11 case began. Twenty stores were closed.

The new case is In re Autobacs Strauss Inc., 09-10358, U.S. Bankruptcy Court, District of Delaware (Wilmington). The prior case was In re 1945 Route 23 Associates, 06-17474, U.S. Bankruptcy Court, District of New Jersey (Newark).

Zayat Stables Confirms Plan With Everyone Paid in Full

Zayat Stables LLC won the signature of the bankruptcy judge on a July 15 order confirming the reorganization plan effectuating a settlement with the secured lender Fifth Third Bank.

Confirmation was a near foregone conclusion after the bankruptcy judge approved the settlement with the bank in late June. There were no objections to confirmation.

The settlement ended lawsuits where Zayat claimed Fifth Third engaged in “predatory lending” practices. The bank, in turn, was seeking authorization to foreclose the business.

The settlement and revised plan provide for paying the bank’s loan in full by the end of 2014. The current principal balance of $28.2 million will be paid down by a minimum of between $3.23 million and $4 million a year. There will be a balloon payment at the end of 2014. Interest in the future will be three percentage points higher than the London interbank borrowed rate.

The bank will also share in part of the proceeds from the sale of horses, with payments applied against the annual minimums.

Unsecured creditors are to be paid in full over two years without interest. Ahmed Zayat retains ownership. The bank had been suing Zayat on a personal guarantee.

The stables, based in Hackensack, New Jersey, filed under Chapter 11 in February in Newark. The stables have more than 200 horses representing collateral for bank. Revenue in 2009 was $21 million.

The case is In re Zayat Stables LLC, 10-13130, U.S. Bankruptcy Court, District of New Jersey (Newark).

Former Crunch Fitness Confirms Liquidating Chapter 11 Plan

Crunch Fitness, at one time a chain of 19 high-end fitness clubs, will be paying unsecured creditors $150,000 under the liquidating Chapter 11 plan that the bankruptcy judge in New York approved in a July 15 confirmation order. There were no objections to confirmation.

Crunch, now formally named AGT Acquisition Wind-Down LLC, filed for reorganization in May 2009 and was authorized in September to sell the business to an affiliate of Angelo Gordon & Co. in exchange for secured debt.

Angelo Gordon, a New York-based hedge fund manager, bought Crunch in 2006 from Bally Total Fitness Holding Corp. and purchased the first-lien debt in late 2008. It retained the chain by swapping $40 million in secured debt for ownership, leaving a deficiency claim of more than $21.6 million.

The official creditors’ committee supported the plan, which was made possible by a $150,000 carve-out allowed by the lender. The lender is also paying costs of the Chapter 11 case, including professional fees. In return, the lender has a release from possible lawsuits.

Although the disclosure statement didn’t tell unsecured creditors how much they could expect to receive from the plan, it did estimate the deficiency claim of the secured lender would have a 1 percent recovery.

The Crunch petition listed assets of $104 million and $102 million in total liabilities. Debt included $56.7 million on a first-lien loan mostly owned by Angelo Gordon affiliates. There was a second-lien credit for another $22.7 million. The clubs, with 70,000 members, were located at filing in New York, Chicago, Los Angeles, and Rock Creek, Maryland.

The case is In re AGT Acquisition Wind-Down LLC, 09-12889, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

New Filings

Retailer Jennifer Convertibles Files for Reorganization

Jennifer Convertibles Inc. and affiliates filed Chapter 11 petitions this morning in Manhattan. The furniture retailer listed assets of $26 million and debt totaling $46.4 million.

The Woodbury, New York-based company reported an operating loss of $13.2 million for the six months ended Feb. 27 on revenue of $48.3 million. The net loss in the period was $13.3 million.

In addition to 154 Jennifer stores in operation at the end of February, the company ran five Ashley HomeStores Ltd. furniture stores under license. Jennifer closed seven stores in fiscal 2009 and said earlier this year it expected to shut seven to 10 stores in fiscal 2010.

Haining Mengnu Group Co. was listed as the unsecured creditor with the largest claim of $16.7 million.

The case is In re Jennifer Convertibles Inc., 10-13779, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Kyoto Grand Hotel in Los Angeles Files to Stop Foreclosure

The owner of the Kyoto Grand Hotel in downtown Los Angeles filed for Chapter 11 relief on July 15, facing mortgage foreclosure the next day.

The 21-story hotel, built in 1977, has 434 rooms. It adjoins the three-story Weller Court outdoor mall which is also in Chapter 11.

The property has two mortgages totaling $44 million. There was a default since January.

Financial problems were caused by a “precipitous drop in revenue starting in the last quarter of 2008,” a court filing says.

The case is In re Little Tokyo Partners LP, 10-39113, U.S. Bankruptcy Court, Central District California (Los Angeles).

Controladora Commercial Files Chapter 15 in Manhattan

Controladora Comercial Mexicana SAB, the largest food retailer in Mexico, filed a Chapter 15 petition on July 16 in New York to help carry out a reorganization that has support from holders of 85 percent of the debt.

Financial problems stemmed from derivatives transactions that resulted a lawsuit in New York by counterparties seeking $1.5 billion damages, a company lawyer said. For Bloomberg coverage on the filing, click here.

The company operated 231 retail stores and 73 restaurants at the end of 2009. The petition said assets and debt both exceed $1 billion.

A Chapter 15 case isn’t a full-blown bankruptcy. If the U.S. court decides that Mexico has the principal bankruptcy, the U.S. court will largely limit its role to stopping suits in the U.S. and helping the company to collect assets. The court in Mexico would rule on the validity of claims and decide how distributions should be made among creditors.

The case is In re Controladora Comercial Mexicana SAB, 10- 13750, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Briefly Noted

Trump Entertainment Consummates Confirmed Chapter 11 Plan

Trump Entertainment Resorts Inc. implemented the Chapter 11 plan on July 16 that the bankruptcy judge in New Jersey approved in a May 7 confirmation order. The plan was proposed by the casino owner and holders of 8.5 percent senior notes. For details on the judge’s ruling turning down a competing plan by Carl Icahn, click here for the April 13 Bloomberg bankruptcy report. The confirmed plan reduces debt by $1.3 billion and is financed in part with $225 million in new equity. For a comparison of the Icahn plan and the Trump plan, click here to see the Jan. 7 Bloomberg bankruptcy report.

Trump Entertainment owns three casinos in Atlantic City. It filed for Chapter 11 reorganization a second time in February 2009. The new petition listed consolidated assets of $2.06 billion against debt totaling $1.74 billion. Listed liabilities included $1.25 billion in second-lien notes, $489 million in first-lien bank debt, $33.2 million in trade debt and $6 million in liabilities on leases, according to a court filing. The companies own the Trump Taj Mahal Casino Resort, the Trump Plaza Hotel & Casino, and the Trump Marina Hotel Casino. The new filing came less than four years after the company emerged from a prior bankruptcy reorganization.

The case is In re TCI 2 Holdings LLC, 09-13654, U.S. Bankruptcy Court, District of New Jersey (Camden).

EnPro’s Garlock Has Final Financing Approval

Garlock Sealing Technologies LLC, a subsidiary of EnPro Industries Inc., nailed down final approval from the bankruptcy judge on July 15 for $10 million in financing. Garlock, a Palmyra, New York-based gasket maker, filed under Chapter 11 in early June to deal with the last 100,000 asbestos claims. Non- bankrupt affiliates are defendants on 30,000 claims. The company intends to pay all creditors in full, including asbestos claimants, so EnPro and all subsidiaries will have releases. There is $194 million of insurance remaining.

EnPro had assets of $1.33 billion and total liabilities of $923.5 million on the March 31 balance sheet. EnPro’s $99 million in net income included $5.6 million of income from continuing operations for the first quarter. EnPro makes engineered products, including diesel and natural-gas engines. It has 44 plants in the U.S. plus operations in 10 other countries.

The case is In re Garlock Sealing Technologies LLC, 10- 31607, U.S. Bankruptcy Court, Western District North Carolina (Charlotte).

Old Chrysler Settles Environment Claim in Ohio

Old Chrysler, formally named Old Carco LLC, agreed with regulators to pay $500,000 to settle more than $40 million in environmental claims related to a former plant in Dayton, Ohio. To read Bloomberg coverage, click here. Chrysler confirmed a liquidating Chapter 11 plan in April. To read about the plan, click here to see the April 21 Bloomberg bankruptcy report.

After filing under Chapter 11 on April 30, 2009, old Chrysler sold the business in June 2009 to the a company 20 percent-owned by Italy’s Fiat SpA. The confirmed plan gave nothing to unsecured creditors aside from proceeds, if any, from a lawsuit against former owner Daimler AG, and then only if the recovery exceeds $25 million.

The petition listed assets of $39.3 billion and debt totaling $55.2 billion. A trust to provide health benefits for Chrysler workers owns 55 percent of new Chrysler. The U.S. government owns 8 percent of the stock while Canadian governmental units have 2 percent.

The case is In re Old Carco LLC, 09-50002, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Daily Podcast

Texas Rangers, Skilled Healthcare, Lehman: Audio

People who made money speculating on Skilled Healthcare Group Inc., developments in the sale of the Texas Rangers baseball team, and an important appeal on the treatment of swaps in bankruptcy are topics discussed in the bankruptcy podcast on the Bloomberg terminal and Bloomberglaw.com. To listen, click here.

Exchange Offer News

Star, Inquirer Parent Announces Exchange Offer

American Media Inc. announced a tender offer where holders of the $355.8 million in 14 percent senior subordinated notes can swap for $103 million in cash and 95 percent of the equity, Moody’s Investors Service said.

The publisher of Star and the National Enquirer is also offering to repurchase all of the $23.7 million in pay-in-kind notes due 2013 for 102 percent.

The swaps are conditioned on the company receiving a commitment of $600 million in new funds, Moody’s said. The new cash will be used in part to pay off $432 million in term loans.

American Media missed the interest payment due May 1 on the subordinated notes. Before the exchange was announced, Standard & Poor’s estimated that holders of the subordinated debt could expect a recovery from nothing to no more than 10 percent.

Twice in 2009, the Boca Raton, Florida-based company obtained relief from the subordinated noteholders, who allowed the payment of interest with more notes.


KB Home Downgraded on Slower Housing Market Recovery

KB Home, one of the country’s largest homebuilders, received a one-notch downgrade from Standard & Poor’s on July 16 because the recovery in housing has been “weaker” than Standard & Poor’s anticipated.

The new S&P corporate rating of B+ matches the action taken by Moody’s Investors Service in June 2009.

S&P also lowered the rating on almost $1.7 billion in unsecured notes to B+. S&P predicts the recovery on the notes in the event of payment default would be 30 percent to 50 percent.

KB, based in Los Angeles, has significant debt maturities in 2014 and 2015. Next year, maturities are $100 million.

Revenue in fiscal 2009 was $1.8 billion. In fiscal 2007 it was $6.4 billion.

Bank Failures

Six Takeovers Bring Year’s Bank Failures to 96

Six U.S. banks were taken over by regulators on July 16, bringing total bank failures for the year to 96.

The failures will cost the Federal Deposit Insurance Corp. a combined $334.8 million.

To read Bloomberg coverage, click here.

There were 140 bank failures in 2009, five times more than 2008. The failures in 2009 were the most since 1992, when 179 institutions were taken over by regulators.

Advance Sheets

Circuits Now Split on Negative Equity on Auto Loans

There is now a split of circuit courts on the question of whether so-called negative equity on a previously owned auto must be paid in full as a condition to keeping the newer car after bankruptcy. The U.S. Court of Appeals in San Francisco, departing from the other eight circuits to consider the issue, ruled on July 16 that negative equity isn’t part of a purchase money security interest and need not be paid to retain the newer auto.

The 9th Circuit in San Francisco said it didn’t split with sister circuits lightly. The Circuit Court said it was “persuaded by the well-reasoned decision of Bankruptcy Judge Bruce Markell.” The appeals court also noted that some of the circuit court decisions going the other way had “strong dissents.”

The question involves 2005 amendments to bankruptcy law creating an ambiguous provision about car loans known as the “hanging paragraph.” The provision acquired its nickname because Congress inserted it into the 2005 reform law without a section number saying exactly where it should go.

The provision, likely intended to be somewhere in Section 1325, means in a broad sense that an individual in a Chapter 13 case cannot cut down the amount of a “purchase money security interest” in an auto loan to the value of the car. Instead, the bankrupt must pay the full amount of the debt, even if it’s more than the value of the car.

Problems in statutory interpretation arise when the so- called negative equity on a previously owned car is rolled into the debt on a newly purchased auto.

The courts on both sides of the issue say that the question is answered by the state law definition of what is or isn’t a purchase money security interest. Only the U.S. Court of Appeals in New York certified the question to the highest court in the New York State system, the New York Court of Appeals. The high court in New York ruled in a 4-3 decision last year that negative equity is covered by a purchase money security interest. The other U.S. appeals courts all interpreted the applicable states’ laws on their own.

In the July 16 decision from the 9th Circuit, the appeals court understood California law not to include negative equity in a so-called PMSI.

To answer the question, the 9th Circuit looked at the official comment to Section 9-103 of the Uniform Commercial Code where the “price” of the collateral includes “expenses” incurred in acquiring the property. The appeals court said that paying an “antecedent debt” isn’t “an expense incurred in buying the new vehicle.”

For more on the issue, click here for the Oct. 12, 2009, Bloomberg coverage on the New York decision.

The existence of a split of circuits is often reason for the U.S. Supreme Court to accept an appeal. The Supreme Court may not allow an appeal in this case because the fundamental issue turns on state law, not federal law. However, the Supreme Court might take the case if the court believes that federal bankruptcy law has its own definition of purchase money security interest. The appeals courts uniformly say the question is one of state law.

The 9th Circuit opinion was written by U.S. District Judge Richard Mills from the Central District of Illinois, who was sitting by designation. The 7th U.S. Circuit Court of Appeals in Chicago, the appeals court for the circuit where Mills sits as a district judge, ruled the other way on the issue on March 1.

The new case is AmeriCredit Financial Services Inc. v. Penrod (In re Penrod), 08-60037, 9th U.S. Circuit Court of Appeals (San Francisco).

Financing Approval Reversed on No Adequate Protection

U.S. District Judge Cecilia Altonaga wrote an important decision last week overturning parts of bankruptcy court orders approving financing and use of cash collateral, even though there was no stay pending appeal. The opinion means professionals and some lenders are required to disgorge payment received during the case.

The opinion on July 14 involved the sale of the unfinished 63-story hotel and casino on the north end of the Las Vegas Strip owned by Fontainebleau Las Vegas LLC. The project ultimately was sold to a company affiliated with Carl Icahn for about $150 million, including the assumption of financing Icahn provided for the Chapter 11 case. After the sale was completed, the Chapter 11 case was converted to a Chapter 7 liquidation in April.

The controversy revolves around a dispute between bank lenders and mechanics’ lien holders about whose security interests come first. The mechanics’ lien holders, with $615 million in claims, contended they come first. The lenders, owed $1 billion, disagreed and said their mortgages have first priority.

In her decision, Altonaga didn’t resolve the lien-priority dispute which is the subject of separate lawsuits in the bankruptcy case.

The bone of contention for the mechanics’ lien holders was a series of orders where the bankruptcy judge allowed Fontainebleau to use cash collateral and in the process gave the banks new liens, called priming liens, to come ahead of all existing security interest, even those of the mechanics’ lien holders.

Later in the case, Icahn provided $51 million in secured financing, again with a priming lien ahead of everyone else. The new financing from Icahn was used in part to repay the banks for cash collateral used during the Chapter 11 case. In appointing an examiner, U.S. Bankruptcy Judge A. Jay Cristol signed an order saying that the examiner’s fees would also have priming status, again coming ahead of the mechanics’ lien holders.

Altonaga reversed the bankruptcy court and said it was an error to grant priming liens without giving so-called adequate protection to the mechanics’ lien holders. She said it was not sufficient that the lending and use of cash collateral would benefit all creditors. The mechanics’ lien holders were entitled to some form of new collateral to protect what they were losing when they were primed.

Altonaga made several rulings of importance for reorganization cases. She said bankruptcy law doesn’t allow priming one secured creditor to provide adequate protection for the use of another secured creditor’s cash collateral. Similarly, professional fees cannot be given priming status unless something new is given to the displaced secured creditor to serve as adequate protection. She also held that the secured creditor who was primed was entitled to something new in the form of adequate protection.

Reduced to essentials, every secured creditor must be given adequate protection when there is a dispute over who has the first lien. Preserving the property doesn’t justify demoting an existing lien.

Altonaga also ruled that the appeal wasn’t moot on the three theories of mootness: constitutional mootness, equitable mootness and mootness under the bankruptcy law section dealing with secured lending. She said the case wasn’t constitutionally moot because some relief could be granted. It didn’t matter if it was impossible to restore the parties to their prior positions completely.

On the issue of equitable mootness, she said it was possible to grant some form of relief. She also noted that equitable mootness is most often used to dismiss appeals from a Chapter 11 plan that has been implemented. The instant case didn’t involve a plan.

Under Section 364(e) of the Bankruptcy Code, she said that the appeal could go ahead against everyone except the lender. Consequently, Icahn was the only party to escape unscathed. Altonaga said that as a third-party lender in good faith, the reversal of financing approval couldn’t upset any of his rights.

The reversal by Altonaga means that the lenders for the time being must repay some $18 million they received from the financing. The examiner and professionals also must repay fees they received.

After the lawsuit is concluded regarding the lien-priority dispute, it’s possible the lenders may recover their $18 million if their lien is held to have first priority.

The opinion, while long and very complicated, is must reading for bankruptcy lawyers and secured lenders in Chapter 11. Don’t be surprised to see an appeal to the U.S. Court of Appeals in Atlanta.

The case is Desert Fire Protection v. Fontainebleau Las Vegas Holdings LLC (In re Fontainebleau Las Vegas Holdings LLC), 09-23683, U.S. District Court, Southern District of Florida (Miami).

11th Circuit Interprets Ambiguity Against Bankrupt

The U.S. Court of Appeals in Atlanta answered a question created by an ambiguity created when Congress changed bankruptcy law for individuals in 2005.

The 11th Circuit ruled on July 16 that an individual in Chapter 13 whose income is above the median must have a five- year plan even though the bankrupt’s disposable income is negative. Lower courts said that the plan need only last three years because the bankrupt’s disposable income was negative.

The Circuit Court reversed the rulings in the lower courts. No other circuit courts have addressed the issue.

The 11th Circuit said its opinion was derived from the plain meaning of the statute, Section 1325 of the Bankruptcy Code. The appeals court also saw the result as being in accord with congressional intent that bankrupts pay the most they can to creditors.

The rule announced by the circuit court means that creditors can file papers to increase payments under the plan for the fourth and fifth years if the bankrupt’s income has increased.

The case is Whaley v. Tennyson (In re Tennyson), 11th U.S. Circuit Court of Appeals (Atlanta).

To contact the reporter on this story: Bill Rochelle in New York at wrochelle@bloomberg.net.

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