LTL Management and the Third Circuit: Financial Distress Required for Good Faith Filings

 

By Candice L. Kline, Esq.

Partner

SAUL EWING LLP
Chicago, Illinois

This post is an excerpt from the forthcoming fifth installment in the Mass
Tort/Third-Party Releases Series in the upcoming CLW magazine.

 

          The recent Third Circuit opinion in In re LTL Management, LLC [1] focuses on when debtors may qualify for bankruptcy protection.  The appeal came from the bankruptcy court’s denial of motions to dismiss the LTL bankruptcy case based on allegations the filing lacked good faith.[2]  

          The Third Circuit examines the parameters of good faith and avoids other key techniques to access bankruptcy, isolate liabilities, and cap the liabilities in mass tort cases such as the legality of nonconsensual third-party releases (not yet ripe in LTL) and the propriety of the “Texas Two-Step” divisive merger and other affiliated-filing practices used in the service of protecting a financially healthy parent company without the hassle of filing bankruptcy itself.

          If viewed narrowly, the precedential opinion merely requires debtors to show some “financial distress” to establish good faith and avoid dismissal.  That requirement could be satisfied by adding a new section to a first-day affidavit, or perhaps more keenly, not waiting until the last minute to hive off the liabilities or to create a new affiliate only for bankruptcy purposes.  If considered more broadly, the Third Circuit may have opened the door to major rethinking in this area of “creative” practice.[3]

          On direct appeal of consolidated appeals by many parties, the Third Circuit reversed the bankruptcy court’s order denying the motions to dismiss and remanded the case to the bankruptcy court with instructions to dismiss LTL’s chapter 11 case.[4]

          The dismissal lifts a litigation stay on talc liability lawsuits and permits plaintiffs to resume their litigation as if the bankruptcy had not occurred.[5]  Although J&J promised an appeal, and has filed a petition for en banc review discussed below, success seems unlikely.  Few arguments seem likely to challenge Judge Ambro’s common sense premise: only debtors experiencing actual financial distress may seek bankruptcy protection.

          Judge Ambro clarifies lofty goals and good intentions “do not suffice alone.”[6]  He emphasizes the intended purpose of bankruptcy protection and limits its access to debtors “in financial distress.”[7]  After concluding that LTL was not in financial distress, the Third Circuit dismissed LTL’s chapter 11 petition, ending the bankruptcy. A petition for rehearing is pending.

          Judge Ambro emphasized that Third Circuit precedent seems to require proof of financial distress to establish a valid bankruptcy purpose and defeat a good faith challenge.[8]  An impaired or deteriorating financial condition, actual and not speculative, is a critical prerequisite for a good faith filing.  Reading Third Circuit cases, the opinion states “the theme is clear: absent financial distress, there is no reason for Chapter 11 and no valid bankruptcy purpose.”[9]  Financial distress is determined case-by-case.[10]

          LTL fell short of proving good faith because it had the financial means through the Funding Agreement to deal with the liabilities.  The Third Circuit held that only LTL’s financial condition matters for this test because it alone is the debtor with its petition facing dismissal.[11]  The good-faith requirement applies to the debtor in bankruptcy, not the corporate family.[12]  Here, the test applied to LTL alone, and it had recourse to cover its liabilities under the Funding Agreement up to $61.5 billion.[13]

          The Funding Agreement was backed by gold-standard corporate resources, with the J&J parent holding a AAA-credit rating, worth over $400 billion in equity value, and $31 billion in cash and marketable securities.[14]  With such financials, the Third Circuit concluded, “It is hard to imagine a scenario where J&J and New Consumer would be unable to satisfy their joint obligations under the Funding Agreement.”[15]

          The Third Circuit has spoken on the first gating issue: good faith filing.  Other important issues, such as third-party releases, remain at issue in the Purdue Pharma appeal to the Secord Circuit (pending) and the Boy Scouts plan appeal in the District of Delaware.  With each decision, the practice of mass torts in bankruptcy will morph and adapt.  Potentially, more legislation may enter the fray.

          J&J promised, and filed on February 13, 2023, a petition for rehearing and rehearing en banc of the Third Circuit’s precedential opinion.[16]  This petition remains pending.

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[1] LTL Management, LLC. v. Official Committee of Talc Claimants, et al. (In re LTL Management, LLC), -- F.3d ---, Case. No. 22-2003 (3d. Cir. Jan. 30, 2023) (precedential).

[2] 11 U.S.C. § 1112(b). Id. at 29 (describing the motions filed by multiple talc claimants seeking dismissal of LTL’s bankruptcy petition).

[3] “That said, we mean not to discourage lawyers from being inventive and management from experimenting with novel solutions. Creative crafting in the law can at times accrue to the benefit of all, or nearly all, stakeholders.” LTL Op. 56.

[4] Id.

[5] Id.

[6] LTL Op. at 18.

[7] Id.

[8] Id. at 35.

[9] Id. at 36. The court adds, “[f]inancial distress must not only be apparent, bit it must be immediate enough to justify a filing.” Id. at 38.

[10] Id. at 38.

[11] Id. at 43.

[12] Id. at 44. (citing Ralph Brubaker, Assessing the Legitimacy of the “Texas Two-Step” Mass-Tort Bankruptcy, 42 No. 8 Bankr. L. Letter NL 1 (Aug. 2022)).

[13] Id. at 46.

[14] Id. at 47.

[15] Id.

[16] In re LTL Management LLC, Petition for Rehearing and Rehearing En Banc, Case No. 22-2003 (3d Cir. Feb. 13. 2023).

Florida Supreme Court Confirms Zero-Tolerance For Misleading UCC Filings

By Jeffrey N. Schatzman, Esq.

Schatzman & Schatzman, P.A.

Miami, Florida

 

            On September 29, 2022, the Eleventh Circuit Court of Appeals issued its opinion in 1944 Beach Boulevard, LLC v. Live Oak Banking Co. (In re NRP Lease Holdings, LLC), No. 21-11742, at *9 (11th Cir. Sep. 29, 2022), which reversed the Florida Middle District and Middle District Bankruptcy Courts’ decisions concerning perfection of a UCC-1 financing statement under Florida law.  The case involves 1944 Beach Boulevard, LLC’s, a chapter 11 debtor (“Beach Boulevard”) action to avoid Live Oak Banking Co.’s (“Live Oak”) blanket lien on its assets. 

            Live Oak had made two $2.5 million loans to Beach Boulevard and attempted to perfect its liens on all of Beach Boulevard’s assets by filing a UCC-1 financing statements for each loan with the Florida Secured Transactions Registry.  However, in its filings, Live Oak incorrectly named the debtor as 1944 Beach Blvd, LLC as opposed to its legal name, 1944 Beach Boulevard, LLC.  In its avoidance action, Beach Boulevard asserted that Live Oak’s financing statements failed to correctly name the debtor, making them “seriously misleading” within the meaning of § 679.5061(2), Florida Statutes and thus rendering Live Oak’s security interest unperfected.  The parties filed cross motions for summary judgment.

            Florida Statutes § 679.5061 addresses the effects of errors in financing statements and provides:

(1) A financing statement substantially complying with the requirements of this part is effective, even if it has minor errors or omissions, unless the errors or omissions make the financing statement seriously misleading.

(2) Except as otherwise provided in subsection (3), a financing statement that fails sufficiently to provide the name of the debtor in accordance with s. 679.5031(1) is seriously misleading.

(3) If a search of the records of the filing office under the debtor’s correct name, using the filing office’s standard search logic, if any, would disclose a financing statement that fails sufficiently to provide the name of the debtor in accordance with s. 679.5031(1), the name provided does not make the financing statement seriously misleading.

§ 679.5061, Fla. Stat.

            The Bankruptcy Court ruled in favor of Live Oak by finding that although Live Oak’s UCC filings did not correctly identify the debtor, the safe harbor provision of § 679.5061(3) was applicable since a search of the Florida Secured Transaction Registry discloses the financing statements containing the wrongly named debtor on the page immediately preceding the initial page that appears when searching by the proper name of the debtor.  The Bankruptcy Court believed that such a search result was consistent with standard search logic and thus the filings were not “seriously misleading”.  The Florida Middle District Court, sitting as an appellate court, followed the Bankruptcy Court’s logic and affirmed.

Beach Boulevard appealed to the Eleventh Circuit where the court certified three questions to the Florida Supreme Court:

(1) Is the “search of the records of the filing office under the debtor’s correct name, using the filing office’s standard search logic,” as provided for by Florida Statute § 679.5061(3), limited to or otherwise satisfied by the initial page of twenty names displayed to the user of the Registry’s search function?

(2) If not, does that search consist of all names in the filing office’s database, which the user can browse to using the command tabs displayed on the initial page?

(3) If the search consists of all names in the filing office’s database, are there any limitations on a user’s obligation to review the names and, if so, what factors should courts consider when determining whether a user has satisfied those obligations?

1944 Beach Boulevard, LLC v. Live Oak Banking Co. (In re NRP Lease Holdings, LLC), 20 F.4th 746, 758 (11th Cir. 2021).

            In analyzing the questions presented, the Florida Supreme Court determined that the more appropriate question was: “Is the filing office’s use of a ‘standard search logic’ necessary to trigger the safe harbor protection of section 679.5061(3)?”, which they answered in the affirmative.[1]  In coming to that conclusion, the Court found that under subsection 1, a financing statement can overcome errors if the errors do not make the financing statement seriously misleading. However, under subsection 2, the Court states that it is seriously misleading and there is a zero-tolerance where the name of the debtor is not correctly stated as required by § 679.5031(1)[2]. 
The Safe Harbor of subsection 3 is only applicable if the Registry employs “standard search logic”.

            In deciding the matter, the Florida Supreme Court analyzed and adopted the UCC’s definition of standard search logic and concluded that Florida’s UCC registry does not employ standard search logic.  Whereas a search using standard search logic will generate a finite list of names, Florida’s UCC registry searches return 20 names on a page starting with the most relevant name.  The results are located in a section of the entire list of filings and a user would have to toggle forward and backwards to find additional results.  The Court agreed with the analysis of Professor Kenneth C. Kettering, that a “search procedure that returns as hits, for any search string, all financing statements in the filing office’s database cannot rationally be treated as a ‘standard search logic.’” [3]

            Since the Florida Secured Transaction Registry does not apply standard search logic, making the Safe Harbor inapplicable, the Court did not reach the questions certified by the 11^th Circuit and held that as long as the Registry does not employ standard search logic, any error in stating the debtor’s name will cause a financing statement to be seriously misleading and render the secured interest unperfected.

---

[1] 1944 Beach Boulevard, LLC v. Live Oak Banking Co., No. SC21-1717, 2022 WL 3650803, at *1 (Fla. Aug. 25, 2022).

[2] (1) A financing statement sufficiently provides the name of the debtor:

(a) Except as otherwise provided in paragraph (c), if the debtor is a registered organization or the collateral is held in a trust that is a registered organization, only if the financing statement provides the name that is stated to be the registered organization’s name on the public organic record most recently filed with or issued or enacted by the registered organization’s jurisdiction of organization that purports to state, amend, or restate the registered organization’s name.

[3] Id. at *12, citing to Kenneth C. Kettering, Standard Search Logic under Article 9 and the Florida Debacle, 66 U. Miami L. Rev. 907, 913 (2012).

Evaluating Fraudulent Transfer Liability for Pass-Through Tax Distributions – Start with the F-Squared Opinion

By Peter J. Klock, II
Partner, BAST AMRON LLP
Miami, Florida 

               

Generally speaking, when a corporation pays dividends or distributions to its shareholders, the law does not consider the corporation to have received “reasonably equivalent value” in exchange for the payments.  For a solvent corporation authorizing and paying dividends in the ordinary course of business, the lack of reasonably equivalent consideration received in exchange for the dividends is a non-issue.  But where a corporation is insolvent, the dividends paid leave it with unreasonably small capital, or it is unable to pay its debts as they mature, dividends paid to shareholders are susceptible to being clawed back via, among other things, claims for the avoidance of constructively fraudulent transfers under applicable state or federal law.

            While resolution of such claims typically hinges on the solvency or insolvency of the corporation at the time of the transfers at issue, under narrow circumstances, defendants may be able to defeat efforts to claw back distributions made for the purposes of paying pass-through taxes.  In her recent opinion in the matter of In re: F-Squared Investment Management, LLC, 633 B.R. 663 (Bankr. D. Del. 2021), Bankruptcy Judge Silverstein thoughtfully analyzed several cases dealing with claims to claw back tax distributions and explained the reasoning succinctly, stating, “a transfer is not fraudulent if creditors are ‘no worse off’ as a result of the challenged transactions.”  

In the case before her, the debtor (a limited liability company) had made a number of pre-petition transfers to its members to pay their pass-through tax obligations.  After the debtor filed for chapter 11 protection, the trustee of the liquidating trust brought a dozen adversary proceedings seeking to avoid distributions to the members, including the tax distributions, as fraudulent transfers.  At the summary judgment stage, Judge Silverstein carved out and granted summary judgment in favor of the defendants on the claims to recover the tax distributions, finding that they had been made for reasonably equivalent value.  Critical to her determination was the fact that the debtor had previously converted from a C-Corp to an LLC, and its shareholders were induced to approve the conversion by a promise that the converted LLC would make quarterly distributions sufficient to cover their pass-through tax obligations.  The operating agreement of the LLC also expressly stated that the members were entitled to receive tax distributions sufficient to cover their pass through obligations, and the tax distributions were actually in amounts commensurate with estimated pass-through taxes (i.e., for periods in which the debtor did not profit, it did not issue tax distributions).

Under these circumstances, the debtor was no worse off due to its payment of the tax distributions.  Had the transferees not approved the conversion, the debtor would have had to pay income tax on its revenue, and the debtor was therefore no worse off as a result of the conversion and payment of distributions (which the Court viewed as one cohesive transaction) to cover pass-through taxes.  For that reason, Judge Silverstein distinguished the case before her from a case which did not involve conversion from a C-Corp to an LLC or S-Corp premised upon the payment to members or shareholders of funds to pay pass-through tax liability.

Bankruptcy trustees, insolvency litigators, and corporate attorneys alike should take heed of the F-Squared opinion and the cases discussed therein.  For those prosecuting or defending claims for the avoidance of fraudulent transfers, the merits of the claim will likely turn on the factors identified by Judge Silverstein.  For those organizing or converting to pass-through entities, the members’ or shareholders’ potential liability for such claims will likely turn on the language of the operating agreement or by-laws. 

Supreme Court Holds that a Final, Appealable Order Results When a Bankruptcy Court "Unreservedly" Grants or Denies Stay Relief

Written by:

Jonathan D’Andrea

Term Law Clerk for Judge Russ Kendig

U.S. Bankruptcy Court, Northern District of Ohio

            In Ritzen Group, Inc. v. Jackson Masonry, LLC, __ U.S. __, (No. 18-938, Jan. 14, 2020), the U.S. Supreme Court recently held that a bankruptcy court’s unreserved denial or grant of a motion for relief from stay constitutes a final, appealable order.  Although the Court explicitly declined to decide whether an order denying stay relief “without prejudice” constitutes a final order, the decision provides a bright-line rule as to the finality of orders granting or denying stay relief.  And, as the Court explained, the ruling will prevent the delay of appellate review of fully adjudicated disputes. 

            The case began in state court as a breach of contract dispute between Ritzen Group, Inc. (“Ritzen”) and Jackson Masonry, LLC (“Jackson”).  Shortly before trial, Jackson filed a petition for relief under chapter 11 of the Bankruptcy Code, halting the state court litigation.  See 11 U.S.C. § 362(a).  In the bankruptcy case, Ritzen filed a motion for relief from stay to proceed with the state court trial.  Ritzen argued that Jackson filed its bankruptcy petition in bad faith, warranting stay relief.  The bankruptcy court disagreed and denied Ritzen’s motion. 

            Ritzen had 14 days after entry of the denial order to appeal the bankruptcy court’s decision, 28 U.S.C. § 158(c)(2), but failed to do so within this time period.  Instead, Ritzen pursued its breach of contract claim against Jackson in the bankruptcy court, filing a proof of claim and an adversary proceeding against Jackson.  But the bankruptcy court found that Ritzen, not Jackson, had breached the contract at issue, and disallowed Ritzen’s claim.  The bankruptcy court subsequently confirmed Jackson’s chapter 11 plan, which effectively barred Ritzen from pursuing its claim against Jackson any further.

            Ritzen appealed the bankruptcy court’s order denying relief from stay and the order resolving Ritzen’s breach of contract claim to the district court.  The district court sided with the bankruptcy court on both issues.  Ritzen further appealed to the U.S. Court of Appeals for the Sixth Circuit.  The Sixth Circuit held that the order denying Ritzen’s motion for relief from stay was a final order, triggering the 14-day period to file a notice of appeal.  Thus, Ritzen failed to timely appeal.

            The issue for the Supreme Court to decide was whether orders denying motions for relief from stay are final and immediately appealable under 28 U.S.C. § 158(a)(1).  A unanimous Supreme Court answered this question in the affirmative, offering several reasons:  First, in Bullard v. Blue Hills Bank, 575 U.S. 496 (2015), the Court held that a bankruptcy court order denying plan confirmation with leave to amend was not final because it did not conclusively resolve the confirmation proceeding.  Bullard, 575 U.S. at 499, 502-03.  Analyzing the current case under this paradigm, the Court explained that adjudication of a motion for relief from stay is a “discrete proceeding,” the resolution of which constitutes a final, appealable order.  Second, 28 U.S.C. § 157(b)(2)(G) describes motions to terminate, annul, or modify the automatic stay as “core proceedings”, and these are listed separately from proceedings regarding the allowance or disallowance of claims, indicating that Congress intended for stay-relief adjudications to be considered final.  Third, resolution of a motion for relief from stay can be significant and consequential, resulting in more than just a determination as to the appropriate forum for claim adjudication, which lends support to the notion that such orders should be considered final.  Fourth, the Court rejected Ritzen’s argument that a stay-relief denial should not be considered final when, as in this case, the bankruptcy court’s decision rested on a substantive legal issue.  Finally, the Court explained that its rule will avoid delays and inefficiencies regarding appeals.    

            Bright-line rules are always easier to remember, and the Supreme Court’s decision in Ritzen provides one: orders granting or denying relief from stay are considered “final” under 28 U.S.C. § 158(a)(1).  Bankruptcy practitioners should be aware of the decision and its effect on the timing of bankruptcy appeals.  See 28 U.S.C. § 158(c)(2); Fed. R. Bankr. P. 8002(a).  

* Disclaimer: None of the statements contained in this article constitute the official view or policy of any judge, court or government employee.